The world’s financial markets are fixated on the issues of European sovereign debt. The inability of politicians to get a grip on the situation is allowing markets to dictate the pace as Greece, Italy and now Spain fall into the spotlight. But on the other side of the world, there is another highly indebted country whose bonds are seen as something of a safe haven and whose equity market is the cheapest it has been for more than 20 years. That country is Japan.
A 20-year bear market has left domestic and global investors light in Japan’s equity market, yet there is now good reason to take a second look. On a dividend yield, price-to-book and, in many cases, price-to-earnings basis, it is an area that has never looked as cheap.
Japanese investors, scarred by two decades of dire returns, have chosen to ignore it. In an environment of low inflation, and periods of deflation, they have been content buying low-yielding Japanese government bonds (JGBs). Rising dividends may reignite their interest.
Scott McGlashan and Ruth Nash, managers of th JO Hambro Japan fund, are finding large numbers of stocks yielding more than 3 per cent, far higher than the yield on 10-year JGBs of just over 1 per cent. If Japanese investors are enticed into the market by these yields, the effects could be profound.
The managers believe the forthcoming interim results could provide further impetus. They are confident that many companies they own will beat forecasts and use the cash on their balance sheets to increase dividends or announce share buybacks, continuing the recent trend.
According to McGlashan and Nash, many companies announced their intention to increase dividends at an earlier point in this financial year, showing growing confidence.
Another trend is that of management buyouts. There have been 16 Japanese listed companies acquired via MBOs in 2011 at an average premium of almost 50 per cent to market value at the time, illustrating that company management see considerable value in Japanese firms even if investors do not.
Recently, manufacturing firms have been the poorest performers in Japan due to concerns that exports will slow as global growth weakens. But positions in retail stocks have had a beneficial effect. Far from reeling in the aftermath of the tsunami in March, the Japanese consumer has been loosening the purse strings and the retail sector has been a bright spot in the market.
Problems in the eurozone or further slowing of global economic growth could derail any revival but disappointment at a corporate level is already factored into Japanese shares. On the whole, they are priced as value destroyers rather than’creators, meaning any good news could have a positive effect on the market. And with Japan well placed geographically, the prospects for many Japanese firms are bright if they can seize the opportunity.
One possible stumbling block for UK investors is a weakening of the yen, which could erode returns in sterling terms. This has been foretold for as many years as I can remember, proving several top fund managers wrong remaining stubbornly strong. Perhaps it will weaken at some point but, if it does, it would probably be compensated by a sharp movement in the Japanese equity market as exporters become more competitive.
As far as the domestic economy is concerned, I do not think Japan is going bust any time soon. The vast majority of the debt is held by Japanese rather than foreign investors and, unlike European nations, its fate is in its own hands and not at the whim of the international bond markets.
Mark Dampier is head of research at Hargreaves Lansdown