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Value Buys

or Value Traps? – Everyone likes to buy things on sale, and investment professionals are no different.  When it comes to cheap investments, Japan’s Tokyo Stock Exchange is the Wal-Mart of all stock markets.  Japan is virtually the only stock market left in the world where you can find an abundance of net-nets, or companies that are trading below their break-up, or net asset value.  Great!  Stocks trading below their break-up value – sounds like a free lunch?  But what if the stock valuations stay low despite management’s ability to increase earnings, banking reform, or an up tick in the local economy?  After all, at the end of the day a stock is only worth what someone is willing to pay for it.

Japan’s stocks are cheap for a reason.  The Tokyo Stock Exchange soared throughout the eighties but suffered a large correction at the end of the decade, followed by an even more over-inflated housing market that crashed and crippled its banking sector.  In response, the Japanese Government made policy error after policy error resulting in over 10 years of economic downturn.  So, stay away from Japan right?  Wrong.

The key to value investing is correctly identifying the catalysts, or events that will occur to unlock that value and lift stock prices towards fair value.  In Japan’s case there are three major catalysts that are looming on the horizon:  1 – continued improvement in the Japanese economy, 2 – the unwinding of the Yen carry trade (the practice of borrowing cheap Yen, and investing in higher yielding US/Australian/European/or other government bonds for a profit), 3 – Japan’s key roll as a natural trading partner with China.  Despite these bullish catalysts, the negative impact on Japanese equities that a widespread, global slowdown in growth, as a result of a severe recession in the US should always be kept in mind.

Jardine Fleming Asset Management, the undisputed heavyweight champion of Asian investments, and managers of the JF Japan Fund a holding within the INTAC Global Developed Market Equity Portfolio made the following statements in their most recent commentary to investors dated December 12, 2007:

The TOPIX and Nikkei 225 were up 2.0% and 1.8%, respectively, as US rate cut hopes and measures to stem the subprime crisis helped boost financial stocks.  This was despite the announcement by Mizuho, Japan's second largest bank, that it would invest USD 1.4 billion in its investment banking division to cover its own subprime losses.  Japanese exporters were lifted by a weaker trend for the yen over the second half of the week, as rising stock markets eased concerns and sparked further carry trades.

We are watching closely the implications of the fallout of the US subprime problem and its impact on the global economy, international credit conditions and exchange rates.  This presents a major risk to equities worldwide.  At this stage we do not envisage a dramatic dislocation to the growth trends in emerging regions of the world that have become increasingly important to Japanese exports over recent years.  Their demands have benefited leading manufacturers of construction machinery, high grade steel and factory automation equipment, amongst others, and have been a primary source of growth in the Japanese economy.  We have yet to see evidence that this dynamic is changing and in fact we have found a number of examples in our recent company meetings to suggest that some of these trends are accelerating.

The economic indicators continue to show that the domestic economy is experiencing a slowdown, in part induced by the introduction of tougher building standards laws. In the absence of a severe downturn in the global economy we would expect the situation to improve in 2008 as lingering deflationary pressures and depressed consumer spending ease in Japan.  On many traditional measures the Japanese equity market now trades on valuations that are attractive in comparison both to global markets and its own history.  Most notably on valuation metrics, which give consideration to the balance sheet such as EV/EBITDA or PBR, Japan offers an attractive proposition.

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In short, if you believe that the US dollar and US economy will continue to decline due to its fundament weakness, and/or you believe that China will continue to grow and demand goods from Japan’s highly industrial and technology driven economy then an overweight, long term investment in Japan may be appropriate for your portfolio.

Investing in Japan at current levels does not represent the same risk profile as emerging markets or other potentially aggressive investments, because the volatility in Japanese stocks, when it occurs will likely be on the upside.  However, there is a considerable amount of inherent risk – opportunity cost, or what you would have made if you invested in something else, and the risk that you might die of boredom before your Japanese stocks wake up from their Rip Van Winkle type slumber.  In a corporate culture that is very different from North America or Europe, it is important to invest with industry leaders like Jardine Flemming that have analysts on the ground in Japan scrutinizing Japanese companies on a full time basis.

Furthermore, we recommend investing in Japanese E quity fund like JF Japan through such well-balanced portfolios as the INTAC Global Developed Market Equity Portfolio.  Your exposure to Japan and the overall Developed Market asset class should be determined by your individual risk/reward profile, time horizon, income and liquidity needs (among other factors), and managed within an overall investment strategy, as is done in the 7 INTAC InvestmentPhilosophies.  

Visit our website at www.intacglobalinvestments.com to learn more about INTAC and the Phoenix Gold Fund, or contact us at sales@intacglobalinvestments.com.

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