Japan and its stock market have been a tough sell for the better part of two decades – and with good reason. Nearly a generation after the collapse of its property and market bubbles in the late 1980s, the country remains hobbled by soaring deficits, debt and periodic bouts of deflation and despair.
There was a time when economists regarded Japan as an anomaly among developed countries – a thankfully rare example of what can happen when timid politicians face an overwhelming financial and economic crisis armed with ineffective policies and an unwillingness or inability to tackle contentious fiscal, banking and market reforms.
But after the numerous policy missteps and sharp reversals of fortune of the past few years in Europe and the United States, we now know that Japan has not cornered the market on official ineptitude or rabbit-caught-in-the-headlights fear. We also know that the Japanese experience is quite likely to be repeated elsewhere, as economic actors shed debt. As the Economist observed recently, “the euro area looks eerily Japanese.”
For the ever-shrinking band of hardy investors still committed to equities, such conditions demand extreme caution. Which is where Toronto-based Burgundy Asset Management comes in. The conservative value shop has been wading into Japanese stocks for the past 14 years of bad and worse times and offers up some hard-earned lessons for a world that is turning Japan-like.
“We think investing in good-quality companies makes sense in any environment. But it’s absolutely critical in difficult and challenging environments,” says Craig Pho, a senior vice-president with Burgundy and the person responsible for its Japanese forays.
He emphasizes that Burgundy is not in the economic forecasting business and is not predicting that the developed world is about to be engulfed in economy-destroying deflation.
“We’re not saying we’re imminently heading that way here. We only recognize that it is a possibility.”
Indeed, judged by the continuing flight of nervous investors into seemingly safe U.S. Treasuries and a handful of other government bonds, the markets seem to be girding for a prolonged period of stagnation, with or without deflation.
“Too many people today believe that swift and bold government and central bank policy can get the world out of any mess,” Burgundy said in a recent assessment. Based on its own experience in Japan, “we are skeptical of this view.”
What Burgundy has learned is that not all companies have similar fates in hard times, Mr. Pho says. The key is to ignore the dreadful economic headlines and focus on which businesses are best equipped to thrive regardless of the conditions.
“We’re not in Japan because we have a macro view. We’re only in Japan because the prices of quality companies are so attractive that we find it hard, as value-oriented investors, to ignore them.
The goal, he says, is to “take advantage of the fear and uncertainty that come along with a very tough macro environment by finding a few high-quality, growing companies that are well-managed, and invest in them for the long term.”
They may get clobbered in the short run, along with the rest of the market. But the key is to remain patient and disciplined. “The growth of these companies should mean that we make money for our clients over the long term.”
INVESTING IN JAPANESE EQUITIES
WHAT LOOKS GOOD
- Shimano World’s biggest maker of bicycle components, with about half world market.
- Keyence: Factory automation solutions using sensors. Not a household name, but It shows up on the factory floors of Samsung and other leading manufacturers around the world.
- Hirose: Maker of miniature connectors used in smart phones, laptops, vehicles and robots. Difficult for other companies to copy or develop their own versions. Essentially to tiny connectors what Intel is to chips.
- Kao: Japan’s version of Procter & Gamble, a leading marketer of soaps, shampoos, cosmetics and household cleaning products. Brands include Jergens lotions, KMS hair products and Ban deodorants.
- Mani: Small maker of opthalmic knives for eye surgeries, miniature suture needles used in delicate operations and dental files for root canals. “These are difficult products to master, in terms of quality,” Craig Pho says.
WHAT TO AVOID
-Financials: “Deflationary environments are devastating for financials,” Mr. Pho warns. “Every day you wake up and the assets on your books are worth less. The collateral against the assets is worth less. But the liabilities don’t change …” That means, every day, your equity is under pressure.”
-Retailers: A hotly competitive market in a weak economy. New concepts easily and quickly copied.
- Consumer electronics: The Sonys, Panasonics, Sharps and Hitachis face a weakening global market, fierce price pressures from Asian rivals and suffer from an inability to hold on to competitive advantages.
-Automotive: Toyota and Honda still produce quality vehicles. But Mr. Pho says he “never felt entirely confident these are companies that highly value their shareholders.”