Trade for the decade - overlooked deep value
Brian Dennehy
Our "trade for the decade" employs a strategy that has never failed us since the 1980s. And while emerging markets and commodities are an obvious call (we still strongly recommend India on a decade view) if you look closer, there is deep value elsewhere. And it is deep value that is being widely overlooked, which is ideal for our purposes, allowing you to build your exposure ahead of the value exploding upwards, and before everyone else spots the opportunity.
In January 2008 edition of the TopFunds Guide we had a headline “dark clouds, golden opportunity”. On the one hand we highlighted the outstanding value in Japanese smaller companies, and on the other hand the inability (even for an optimist) to identify the catalyst for a recovery.
Here I want to update this opportunity, and the way to exploit it, with a strategy which has never failed us, going back to the 1980s.
Japan continues to divide opinion sharply, yet you cannot ignore it – it is the 4th biggest economy in the world, with the fourth biggest stock market. It has just “enjoyed” the 20th anniversary of its stock market peak in December 1989, from where it fell in excess of 80% (to March 2009), and is still down 72% (on the Nikkei 225).
Analyst John Mauldin believes that the shocker this year will be a collapse in Japan, which he calls “Weimar-in-weighting”. In contrast Morgan Stanley believe Japan has a real chance to restructure, and that it does not face an imminent fiscal collapse.
If it can begin to deal with the Government debt burden, that will address one of the pillars of gloom. The other is their demographic problem, an ageing population problem more extreme than elsewhere, which cannot simply be legislated away. Yet domestic Japanese businesses have been adjusting to this problem, as well as relatively subdued growth, for a couple of decades, and Japan now has unrivalled experience in corporate survival and profitability. Moreover, the impact of an ageing population is complex – ageing populations will generate their own booming business sectors.
For example, a dynamic small business will not keep manufacturing nappies, when incontinence pants are the growth market! Sorry if that’s a bit too graphic.
The Nikkei 225 index is dominated by larger global businesses and exporters, a bit like our own FTSE 100 index. While there is value there, it is amongst the domestically-focussed small caps that there is deep value, and it is such deep value that we must look for in any “trade for the decade”. Even back in 2008 40% of stocks in Japan traded under their asset value, and now the prices for smaller companies are such that they average 20% below their asset value – this must make it the best value sector in the world.
Problem is, as I said above, that no one knows what the catalyst will be for a lasting recovery, and it would be silly to try and time this market precisely – just because a market has more than halved does not mean it cannot halve again. And that is why our “trade of the decade” is to drip feed into a smaller company fund in the years ahead. If prices go down further, or stay low for longer, you simply buy more and more at depressed prices until the recovery (whatever the catalyst) kicks in. Since the 1980s this approach, to buying deep value and volatile markets has never failed us and our clients – you just need to be patient, and then enjoy the profits when the market or centre eventually explodes upwards, whenever and from whatever level.
We are encouraged by the deep pessimism over Japan in many quarters, and by the fact that most foreign investors threw in the towel some years ago. Yet, and just whisper this, there is one interesting catalyst for change that has largely been dismissed...
..in August the DPJ enjoyed a landslide general election victory, overthrowing the Liberal Party after 50 years. The DPJ has won a huge mandate for change, but, unlike in India, initial enthusiasm has turned to scepticism. Yet the DPJ surely understand that Japanese growth must increasingly rely on increasing domestic consumption, and that after decades of conservatism it is now a time to be bold (as the FT put it, 8/1/2010).
So the new Government has been elected at the bottom of the economic cycle (at least the current one!), expectations are poor, stock market values are rock bottom, and foreign investors are nowhere to be seen. This has “buy” written all over it if you will commit to monthly investing and are prepared to be patient.
Buy the M&G Japanese Smaller Company fund. It has performed substantially better than the small number of alternatives over the last year. You can’t invest monthly online, so please ask for the application and we will send it through.
P.S. for those that still “don’t get it” with monthly investing consider this. If you had invested monthly into the M&G fund from when we originally recommended it in January 2008 (one of the worst times ever to invest?) the total value would now be 21% higher. On the other hand if you had invested a lump sum into the MSCI Japanese Smaller Company index it would now be down 29%. Monthly investing into volatile markets is very powerful.
Date: 08.01.2010