Most Japanese value stocks look fundamentally unattractive, and despite restructuring announcements ...
Most Japanese value stocks look fundamentally unattractive, and despite restructuring announcements from the 'old Japan', a degree of caution is needed for long-term investors.
This is because these announcements tend to focus on cutting labour costs to increase profitability. This can work in the short-term, but most produce products that have little pricing power within declining industries that are beset with over-competition.
This is not to say that value investing in Japan is dead. Some value stocks offer long-term potential for earnings enhancement. However, after making extensive company visits to the 'old Japan', we remain unimpressed by the majority, detecting no signs of the changes necessary to introduce shareholder value or profits growth. Also with the Japanese economy still in the doldrums, cyclical industries will remain under pressure earnings-wise.
So the attractive area for investors remains 'new Japan', characterised by companies in technology, services and telecommunications. These will continue to benefit from global trends and investor demand, and although the short-term correlation between Japanese & US technology stocks has caused volatility, there are arguments why it will deliver renewed outperformance. There is little risk of inflation or of a rise in short-term interest rates.
Investors should remember some US$50bn-worth of domestic post office bond redemptions are expected. Even conservative expectations that 10% will find its way into equities would provide a significant boost. We expect domestic institutional equity exposure to increase. The expectation must be that new Japan will benefit most from this influx of money into the stockmarket, as they are the only sectors whose fundamentals justify investment.
Further encouragement for Japanese shareholders may also come from the advent of western-style M&A activity. Agreed takeovers rose 190% to $37bn in 1999. Hostile M&A is confined to two unsolicited bids. But a successful hostile bid is only a question of time. This should concentrate the minds of Japanese managers to focus on raising returns for shareholders.
One worry is the strength of the yen, but efficiency gains are compensating for higher currency levels. We forecast a trading range of ¥100-120 to the dollar during 2000, and do not expect adverse effects for the equity market.
We believe the correct long-term portfolio strategy is in the new Japan, and remain aggressively overweight in this area. However, an open mind should be kept on attractive value companies on a stock-specific basis.
New Japan will continue to develop attractive products whilst delivering on profits and earnings growth, and therefore attract the lion's share of investor interest.
Richard Whittall is fund manager at Jardine Fleming Asset Management
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