Some of the long-standing bulls have thrown in the towel.

Jim Grant, for example, was a general partner in Nippon Partners from 1998-2010. The idea was to invest in undervalued Japanese securities, of which there were many. Nippon Partners closed up shop in December 2010 because it wasn’t making any money.

Why?

“Japanese corporate managers, by and large, don’t own equity,” Grant said. “They have a platonic interest in the stock price.” In Japan, there is not much of a market for corporate takeovers, activist investors and the like. Management teams are entrenched. Shareholders are unimportant.

“You get tired,” Grant writes. “The last straw was when one of our companies was selling at a huge discount to everything and announced that it would undertake a capital investment larger than its stock capitalization.”

Maybe this will be the catalyst that sparks some life in Japanese equities. After all, there is precedence for the creation of great wealth during a time of lessening government involvement. Even in Japan.

At the Agora Financial Safety and Survival Summit, I talked about the Japan. As I said earlier, the great appeal of Japanese stocks is how cheap they are…

This table below, from Symphony Financial Partners, which runs a Japan-focused fund, shows you the percentage of Japanese stocks that meet three tough valuation criteria:

However, as the Symphony guys point out, “low valuations and cash-rich balance sheets are all chants we have heard before.” The common lament of an investor in Japanese stocks is that they are cheap and stay cheap, that the management teams do nothing to unlock the value in their companies, that they just sit on the cash or blow it on dumb projects.

What’s different this time? “The real change,” they continue, “is the discernible increase in high premium M&A/MBO activity.” (MBO stands for “management buyout” and is when a management team buys out a company, taking it private.)

For the first nine months of 2011, there were more MBOs than in all of 2010. It looks like it will be a record year for MBOs in Japan. What’s interesting is the fat premiums they are paying to make those deals. On average, buyers are paying 50% above the stock market price!

In a September note, the Asian research firm CLSA gave six reasons for the increase in mergers and acquisitions in Japan:

• Japan is dirt-cheap.
• The rules have been changed, with the specified aim of spurring M&A.
• Companies have so much money it is burning holes in their pockets.
• Even if companies don’t have the money themselves, banks are falling over themselves to lend them the money.
• Corporate governance just overtook the U.S. (40% of U.S. companies have poison pills, 45% have staggered boards — which means it takes many years to fire the board — and 70% have golden parachutes. These are not problems Japanese investors have to handle.)
• Rules on what constitutes a monopoly just got wildly more liberal — from the old, parochial domestic market view to taking a worldview of market share: Nippon Steel/SMI may have had a combined 40% share in Japan, but it had less than 3% global share.

Maybe, just maybe, a fire has been lit under Japanese shares… this is a market you should not ignore.

Sincerely,

Chris Mayer
for The Penny Sleuth

Why You Shouldn’t Ignore This Beaten Down Market… was originally featured in the Penny Sleuth.

While most investors have kept their eyes glued to American markets over the course of the recession of 2008 and 2009, Japan has been host to its own set of economic problems. And as more eyes turn to the Japanese economy, a potentially profitable ETF play is emerging right before us.

Here’s how you could benefit from Japan’s deflationary woes…

Boom, Bubble, and Bust

More than twenty years ago, Japan was experiencing an economic boom unlike anything seen in a generation. The Japanese car industry was gearing up as a serious competitor to the big three American automakers, and Japan’s tech sector was beginning to find its legs. Ever-climbing Japanese stocks became hugely popular in the financial world, and real estate in Japan rocketed along with them.

By 1989, property prices in Tokyo’s most desirable neighborhoods reached as high as $93,000 per square foot, making it the most expensive city in the world. But that prosperity wasn’t to be long-lived.

Over the course of three days in 1990, Japan’s asset price bubble burst, and the Tokyo Stock Exchange lost $400 billion in value. But that was just the tip of the iceberg. Over the course of the next 14 years, the Japanese economy continued its fall and subsequent stagnation – a period of time known simply as “the lost decade”.

Japan’s problem wasn’t unfamiliar. In the years after World War II, Japan’s fast-growing economy became a hotspot for stock market and real estate speculation fueled by high-risk, subprime debt. When the asset price bubble popped, it caused a chain reaction that put the Japanese economy at a standstill.

In 2007, Japan looked like it was finally regaining economic ground as real estate prices rose for the first time since 1990… then the subprime mortgage crisis happened here in the United States, throwing economies across the world into a tailspin.

Ironically, it was almost the exact same circumstances that lead to Japan’s asset price bubble that ushered in the recession we’re facing today.

Does Deflation Spell Doom for Japan?

But the economic problems facing Japan and the United States are far from the same. That’s because while the U.S. has maintained a moderate rate of inflation for the duration of the recession, Japan is currently on a crash course for deflation.

In essence, strong deflation is the equivalent of pulling the handbrake on the economy.

Unlike inflation, where the buying power of a dollar decreases over time (the reason you can’t buy a McDonald’s hamburger for 15 cents anymore), deflation causes the buying power of money to increase. And while that might sound attractive, the economic consequences of deflation far exceed the benefits.

That’s a serious concern according to Fed Chairman Ben Bernanke and his league of economists. “Deflation of sufficient magnitude may result in the nominal interest rate declining to zero or very close to zero,” explained Bernanke to Washington D.C.’s National Economists Club back in 2002.

“Once the nominal interest rate is at zero,” he continued,  “…no further downward adjustment in the rate can occur, since lenders generally will not accept a negative nominal interest rate when it is possible instead to hold cash.”

When holding onto cash is more lucrative for lenders than making loans, credit markets seize, and economic activity screeches to a halt. Deflation also means that current debts – like a $300 car payment – become comparatively huge amounts of money to dole out.

“Profits fall, then wages come down, then consumers stop shopping,” Junko Nishioka, chief Japan economist at RBS Securities Japan told Bloomberg. “And because people aren’t shopping, companies lower prices. That’s the process that we’re starting to see. It isn’t easy to break out of.”

Ben Bernanke and the powers that be have made it clear that they’ll do whatever it takes to avoid deflation right now here in the U.S… But that’s not what’s going on in Japan.

The inflation (or deflation) rate is measured by the Consumer Price Index – an index that measures the prices of a basket of consumer goods. As the CPI drops the risk of deflation rises substantially. In May Japan’s main index of consumer prices dropped 1.1%, the biggest decline since 2002. That marks the fifth straight month of price decreases in Japan.

Land of the Rising Yen

Through all of this, the biggest winner has been Japan’s currency, the yen. As deflationary pressures rise, giving each yen more buying power, the currency’s value relative to other countries’ money rises as well.

Since last August, the yen has gained 17.9% against the U.S. dollar and nearly 30% against the Euro, making it one of the most attractive and powerful currencies right now for Forex traders.

That deflation-driven bull market in the Japanese yen has made for an interesting ETF play as well. At present, there are a number of ETFs and ETNs that trade in concert with the ebbs and flows of the yen. Some of the more popular funds include the CurrencyShares Japanese Yen Trust (NYSE: FXY), iPath USD/JPY Exchange Rate ETN (NYSE: JYN), and WisdomTree Dreyfus Japanese Yen Fund (NYSE: JYF).

While each of these funds has a somewhat different investment objective, FXY is the most heavily traded by far, and most liquid.

As you can see from the chart above, FXY’s price action hasn’t been calm and steady, but it has followed an overall uptrend over the course of the last year. After a double top in January, the fund’s price retraced around half of its previous rally before pushing back up. That’s a good sign that suggests shares of the ETF are set to break or at least match the previous high.

Surging volume on upward price movements confirms that investors see the yen pushing up.

FXY looks like it could be finding support on at its 200-day moving average on a pullback. If that happens, it’s time to think about going long on the yen.

While it’s very likely that the Japanese government will step in and attempt to curb deflation before it starts in earnest, their actions won’t be felt until much later in the game. Currencies are very susceptible to politics and world changes, so keep a tight stop on this ETF if you’re considering a short-term trade.

Cheers,
Jonas Elmerraji

July 15, 2009

Profit from Japan’s Deflationary Woes was originally featured in the Penny Sleuth.