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An investment of ¥1,000 in Japan’s Nikkei index would have grown to ¥1,270 over the past 30 years. Meanwhile, $1,000 invested in the US’s S&P 500 would now be worth $8,600.
Visit both countries and you might be puzzled that the share price performance of companies could be so mediocre in one and so successful in the other. I am not advocating the state of a country’s public transport system as a reliable investment guide. But the efficiency and cleanliness of Narita airport and the trains into Tokyo contrast dramatically with the shambles of New York’s Newark airport and the city’s oft-vandalised subway.
The difference at least prompts me to question the current balance of market valuations. In the mid-1980s, when I began my career, Japan made up more than 40 per cent of the global index; today it is just 6 per cent. US equities made up 33 per cent; today it is 62 per cent. I was too inexperienced to suggest the index was unbalanced then. I am old enough to know that it might be today.
Over the years I have found that taking note of valuations can help steer you around trouble. Equities are generally valued according to their earnings (or cash flow) and growth potential. This can change swiftly during recessions, times of inflation and when interest rates rise.
An alternative method concentrates on book value — how much a company’s net assets are worth divided by the number of shares. Unhelpfully, accountants define this differently from country to country. All the same, book value per share offers investors a simple measure of how much company they get for their money.
For Japanese shares it is a lot. Mitsubishi UFJ bank has ¥18tn of book equity and the shares are valued at ¥12tn, so you can buy its shares at a 33 per cent discount to book value. JPMorgan in the US has $290bn of book equity and is valued at $410bn, a 40 per cent premium to book.
This difference is accounted for by the two companies making very different returns: MUFJ makes 6 per cent on its book equity and JPMorgan 14 per cent. However, this might change. The US could face recession this year, while Japan and China are now reopening after Covid. And then there is the issue of exchange rates.
In many ways, the currency situation today reminds me of the mid-1980s. The US had raised interest rates sharply to counter inflation, which had the unwelcome side effect of making the dollar rise strongly and fuelling record Japanese exports to the US.
Central bankers eventually met at New York’s Plaza Hotel and agreed to try to lower the dollar’s international value. This led to a snowballing boom in the yen and Japanese assets, ending with a mighty bubble that popped in 1991. Could we be in for a repeat?
Current conditions certainly have much in common with the Plaza Accord moment. US rate rises last year meant the dollar went from buying ¥115 at the start of 2022 to nearly ¥150 by October — great for Japanese exporters and a factor in Japan finally beginning to “enjoy” some inflation.
Haruhiko Kuroda, governor of the Bank of Japan since 2013, has focused policy on improving growth prospects and eliminating the country’s persistent deflation. Japan’s economy has grown on average just 0.4 per cent a year over the last four decades. Economists have blamed the shrinking population and deflation.
Falling prices might sound appealing, but they choke economies. Kuroda’s very low interest rates (they are currently minus 0.1 per cent) were designed to bring back modest inflation to promote consumer spending and business investment.
Whether it is these policies, the higher oil price or the falling yen that have done it, Japanese inflation last December was 4 per cent after 30 years of stagnant prices. More importantly, wage inflation is catching up, averaging 2 per cent in the year to September.
This leaves the Japanese equity market full of companies loaded with cash, many selling world-leading products (such as robotics) and with incentives to invest for the future. Meanwhile, the government is addressing the population problem — increasing the payment to couples when a child is born from about ¥420,000 (£2,600) to ¥500,000 from April.
Kuroda retires the same month. The BoJ can finally, perhaps, move away from ultra-low interest rates. Kuroda’s controversial decision last month to change its yield curve control programme can be seen, in simple terms, as a signal that Japanese interest rates could rise.
This has led the yen to start to recover against the dollar — as I write, it is ¥128. Hedge fund managers are salivating, shorting Japanese government bonds, which we would expect to fall in value if interest rates rise. This short is known as a “widowmaker’s trade” because of the number of careers it has destroyed. It is not that the idea is bad, just that it can take a long time to unwind.
Rising interest rates at home could also be enough to make Japanese financial institutions — anxious to avoid currency losses — bring back their huge foreign bond holdings, and boost the yen and weaken the dollar.
Confused? I would not be surprised. This has baffled better brains than ours. It is sufficient to know that interest rate moves are triggering huge shifts in the currency markets. The dollar looks overly strong. If it is going to weaken, it makes holding dollar assets less appealing. But a strengthening yen makes Japanese stocks more attractive.
In Japan you can buy great companies at tremendous prices and enjoy the dividends while you wait. I think Japanese banks look particularly interesting — it would take only slightly higher interest rates for profit margins to improve sharply.
Suffice to say I have 12 per cent of my funds today in Japan — twice the weight of the index. Meanwhile, I am relishing my next trip there, knowing the trains will be clean, fast and perfectly on time — and that a lot of companies are similarly well run.
Simon Edelsten is co-manager of the Mid Wynd International Investment Trust and the Artemis Global Select Fund
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