Many international markets have struggled over the last few years, with China being the most recent.
But amidst all that, the Japanese market has quietly put up some solid numbers.
In fact, the Nikkei index is up 37% in dollar terms since early 2013.
Some of this is due to a weaker yen, which has spurred exports and made foreign sales and profits more valuable in yen terms. Cost cutting and incremental increases in productivity are also contributing to the climb.
Here are the trends as well as the companies and markets that are on the up and up.
Big and Little
The sharp pullback in fuel and other commodity inputs has helped improve margins for many firms.
Japan has 3,400 listed companies led by the Nikkei index of 225 bellwether names. The Nikkei recently rose to almost 19-year highs recently, mainly due to gains in these big-name exporters.
But the broader TOPIX index, which consists of nearly 1,900 companies, hasn’t reached its 2007 peak, as middle-market firms relying on domestic spending are struggling to ramp up earnings.
Both markets have posted big gains in absolute terms since Prime Minister Shinzo Abe launched his aggressive stimulus program, with the Nikkei getting a push from foreign inflows.
Meanwhile, a renewed focus on shareholder activism and value has driven a surge in return on equity over the last few years, from 5% to 8.5%. Still, that’s below the global average of 12%.
The result is that about 40% of the shares for smaller companies in the TOPIX have a price-to-book ratio below one, meaning they trade below book value and have a market capitalization below their net worth. By contract, fewer than 20% of companies on the Nikkei trade below a price-to-book ratio of one.
Many smaller companies in Japan are taking actions to improve performance, such as increasing exports, buying back stock, and increasing dividends.
To take advantage of the large company-small company valuation gap, you could buy into the iShares MSCI Japan Small Cap (SCJ) exchange-traded fund.
All Paths Lead To…
There are a couple of other trends that should boost Japanese shares.
Japan’s $14.2 trillion in household assets serve as rocket fuel for the market as only 15% of it is invested in stocks right now.
Japan launched its version of the IRA account last year, with 8 million accounts opened up already.
With 26% of Japanese over the age of 65 and 50,000 Japanese over the age of 100, Japan’s $1.2-trillion Government Pension Investment Fund and postal bank have sharply increased allocations to international equities in order to generate higher returns. This, in turn, has created opportunities for international investors.
Then there’s the political angle.
The key question in this arena is whether Prime Minister Abe’s third arrow of reform allows the economy to grow faster.
Mr. Abe continues to build support within his Liberal Democratic Party, which might embolden him to make some structural reforms. The approaching Trans-Pacific Partnership trade deal offers an opportunity for this.
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Any movement on Japan’s structural reforms in the areas of retail, labor, agriculture, tax, and financial services regimes would be a positive for Japan and for global investor sentiment.
Take It to the Bank
Mitsubishi UFJ Financial Group Inc. (MTU) runs one of Japan’s biggest banks, the Bank of Tokyo-Mitsubishi UFJ. The bank continues to add market share in the Asian corporate loan market.
While European and U.S. banks were busy regrouping and downsizing after 2008, firms looking to borrow had nowhere to go. The Japanese banks have leaped into the breach and are “now dominant in Asia,” according to Portfolio Manager Taizo Ishida of Matthews Asia.
Mitsubishi shares trade at only 6.9 times trailing earnings for the fiscal year that ended in March. Yet analysts expect the company’s earnings to rise 15% annually over the next three to five years.
Even more impressive, this stock is trading at only 68% of its book value despite a 52% operating margin and quarterly revenue growth of 20.5%.
Another interesting trend that’s boosting growth is Japan’s increased defense spending and stronger defense posture.
Japan’s defense budget for 2015 is the biggest ever, in response to China’s increasing military influence in the region and Beijing’s claims to a group of disputed islands administered by Tokyo.
The JPY4.98 trillion ($42 billion) outlay is up 2% from last year and marks the third straight increase after more than a decade of cuts.
Try looking at Fuji Heavy Industries Ltd. (FUJHY), which makes Subaru cars and also builds helicopters for Japan’s defense forces. Fuji Heavy recently won a JPY35-billion ($293-million) settlement from Japan’s Ministry of Defense after a contract to build attack helicopters was pared down.
Its shares trade at just under 10 times projected earnings. And it’s hard to find an analyst who doesn’t like the stock, even though the share price has climbed a staggering 487% in the last five years in dollar terms.
While the focus of the financial media is overwhelmingly on China, Japan is quietly getting back its mojo.