Dec

11

Whither Japan? from Dan Grossman

December 11, 2009 |

I used to do a lot of business in Japan and I think very highly of Japanese businessmen (unfortunately they rarely include women at high levels). They have an industrious, highly intelligent population, are very interested in business, and a good base as the second largest economy in the world.

It is a great mystery to me why they (and their stock market) have not done better in recent years and I have never seen any good explanation of it. Okay, they had a bubble that burst, government policies that were not great, and they have an aging population. But so what? They had plenty of opportunity to recover on their own in spite of whatever the government has been doing. (BTW their government policies could not be any worse than our current ones, so if government policies are the test, we're in big trouble.)

Has anyone seen or can anyone give a decent explanation of why Japan has lagged?

Ken Drees writes:

1. LDP party out of power after 55 years.

2. Exports and profits slumping via USA trade like others Asian exporters.

3. Big(gest) holder of USD denominated debt.

4. Aging populaton (nothing new), but 81 billion spending package just announced, more internal stimulus to follow?

5. Need to diversify their surplus holdings like others (China, Brazil, Russia, et. al.)?

6. New party administration playing a little differently with USA — recent Obama trip no real results, prior to that some grumblings about USA debt, etc.

7. Japan equities — bottoms in 1998, 2003, 2009 — skewed symetric reverse head & shoulders – or just bumping along the bottom?

8. Will need to strengthen export markets everywhere and keep USA markets open and profitable. Japan's growth lies with its neighbors if USA doesn't fix itself.

9. Yen carry trade over, yen rising — conflicts with strategic direction that exports and export profits need to be robust.

10. Zugszwang-lite Japan — any small move doesn't change game for the better. Are there any good moves available?

How will the new party lead? If they cannot rope in the yen to improve exports can they stimulate spending via QE and weaken yen at same time? Or is this approach too slow and meandering? There seems no real strong moves available unless global imbalances happen first and allow Japan countermove possibilties. Japan seems still to be unable to escape via its own power.

Is Japan getting tired of being tired?

Charles Pennington adds:

A broad-brush explanation is that the Nikkei got way out of line with other world markets and has spent the past 20 years returning to normalcy.

The Japanese price to earnings ratio was "well over 100" in the late 80s, and now it's 33 (reported by today's Financial Times), still higher than the US at 22. Earnings for the S&P are up about 2-3 times over their level in 1989, and perhaps the Nikkei's are as well, but if the P/E fell from, say, 200 down to more normal value of 33, a value much more in-line with other world markets, well, that explains a lot.

The Chair will rightly point out that this is retrospective, descriptive, and not predictive, that Japan's interest rates are (or at least were) lower, that the accounting may be different. Also, Mr. Grossman doubtless already knows all these figures, so he is looking for a better explanation, which I don't have.

Kim Zussman adds:

Country-stock could be like "best company" studies, showing admired firms under-performing the rest. Presumably established/successful companies/economies have less upside than currently dire situations. And more downside? 

Vince Fulco replies:

To the list I would add traditional factors such as:

1. Shareholders — very far down the societal list of all stakeholders in the corporate world. The stock market is generally considered more for gambling (no jokes Dr. Z!)

2. Much heavier reliance on debt financing (too much) due to roots in maibatsu/keiretsu structure whereby a conglomerate's banking branch handles all the financing needs

3. No Carl Icahn or Guy Wyser Pratte influence to shake up entrenched mgmts and unlock under-utilized assets. The quote is 'the nail which sticks up gets pounded down'. A few have tried over the years but are usually labeled degenerates or cowboys and run out of town one way or another.

4. Years of very low ROI, white elephant projects by the government, to keep happy important constituents of the LDP (the old group in power) such as construction and the mob — i.e. the bridge to an island with 50 people on it, which we almost got in Alaska a few years back.

5. Legacy obligations which haven't been addressed but simply kicked down the road as we've emulated so well in the last 12 months.

Ken Drees responds:

Mt FujiVince, Kevin, Kim and Charles have all provided excellent observations as to Japan's inbred entrenched-ness, inabilities to move, and relative over valuations. Also, the idea that is was the once high flyer status albatross, so all these past behaviors are in the rear view mirror, yet they continue to taint the view of Japan as an old has-been power country. But change agents may now be inside this yesterday/today paradigm. So far Palindrome's reflexive reinforcement of trend is still in force. The malaise continues. Will some new change agent surface? Will the reflexive reinforcement finally be breached.

The early elements for a change exist. To bet on a new bullish Japan is a long shot. But how much money can be made betting the field? Tax policy can be repealed, monopoly/hands in hands can be abolished, small investors can be made more ownership level. All the levers to lift the old dead stump and turn it over are at the ready. Or is this a dead end due to lack of will? Is Japan a stunted growth, never ever to leave off-broadway? If a global imbalance rises up, will Japan change tack and ride out on a new wind? I am watching Japan, if only since they since they are shackled to the USD. Maybe the impetus for change is at hand. This new administration in Japan — what do they owe the US? 

Stefan Jovanovich replies:

The Japanese are certainly not hidebound where their Navy is concerned. They are the dominant sea power in their part of the world. From the folks at StrategyPage.com:

"Japan is currently the second largest naval power in the Pacific (after the United States), with a total of 32 destroyers, nine guided-missile destroyers, and nine frigates. The older Tachikaze-class guided-missile destroyers are being replaced by the new Atago-class destroyers. Japan also has 16 modern diesel-electric submarines. The Chinese navy is larger in terms of ships. They have 25 destroyers and 45 frigates. However, of these 25 destroyers, 16 are the much older (than Japanese equivalent) Luda class. Most of the frigates are the obsolete Jianghu class ships. China has 60 diesel-electric submarines, but most of them are elderly Romeo and Ming class boats. China's Han class SSNs (nuclear attack subs) are old and noisy. In terms of modern vessels, China is not only outnumbered, but the Japanese ships spend more time at sea and the crews are better trained. The Chinese are also at a disadvantage when it comes to naval air power. Most of China's naval fighters are old. They have a growing number of modern J-11s (a copy of the Russian Su-27) and the Su-30MKK. Japan is almost at parity in terms of numbers (187 F-15J/DJs and 140 F-2s to 400 Chinese J-11/Su-30MKKs). Japan has better trained pilots, although China is trying to close that gap as well."

Yishen Kuik adds:

The attention to detail and sense of duty of their workforce is amazing, and the public infrastructure in Tokyo is of a very high quality — certainly better than Boston, DC, New York or the Bay Area. Tokyo is much bigger than all these four areas. It makes New York seem small.

It's not entirely clear to me why their equity markets haven't done better, but the "obvious" explanations of long term multiple contraction and shrinking internal aggregate demand seem to be correct.

I believe GDP per capita in Japan has been rising all along at the same pace as in the US since 1989, so it isn't as if quality of living in Japan has been frozen at 1989 levels. From what I can tell walking around the streets, they still enjoy a comparable standard of living to anywhere in the OECD, and have an unemployment rate (whatever that means in Japan) of 5.0%

Henrik Andersson replies:

Some investors are expressing great fear about the debt given the large amount maturing in the coming 12 months that is held by citizens, as Yishen writes, and given it has "no foreign demand, no domestic savings, structurally declining tax receipts and savings due to demographics, etc." Any views on this?

The top line numbers for the country are stagnant, but the per capita numbers don't look so bad. Japan might have a ton of public debt, but most of it is yen denominated and some 3/4 of it is held domestically by its own citizens.

Dan Grossman writes:

Two thoughts perhaps follow from the helpful comments of Prof. Pennington and Mr. Kuik:

1. Based on the two-decade decline in average Japanese stock PEs from 200 to 33, why shouldn't average US stock PEs decline further from the current 22 if government policies following bursting of the bubble are equally ineffective in the US as they have been in Japan?

2. If since 1990 the U.S had avoided illegal and legal immigration anywhere near the extent to which Japan has, the US unemployment rate would probably also be 5%.

Vitaliy Katsenelson adds:

Please look at slide 14. Japanese valuations at the of 1989 were incredibly high, add to that a lengthy deleveraging process on the corporate side and leveraging (debt to GDP has tripled) on the government side and you also have anemic economic growth.

Vince Fulco writes:

Here is fascinating article in the WSJ re: a foreigner helping a small japanese village manage the downside of the demographic slowdown. One wonders how much more pervasive this sclerotic 'no change' attitude really is…

Charles Pennington adds:

There's a nice column by Lisa W. Hess in the Dec. 28 Forbes about investing in Japan.

She claims that small cap companies are even more undervalued than large cap, and recommends buying the Topix rather than the Nikkei.


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