Wednesday, February 14, 2007

Market Internals Update: Big Remains Beautiful

It is bad enough for overseas Japanese equity investors that for eight months Japanese equity funds have done nothing in dollar terms, while the US market has seen dollar returns of 20% and the European market approaching 30% in dollar terms. But in Japan, even with its indices up 15% since its mid-year lows, the currency is, sadly, down nearly a like amount, such that the resulting chart looks like my EKG while watching the evening news.

But the even bigger insult to active managers in Japan is that most Japanese stocks have continued to underperform the major indices. So much and so thin their ranks, that merely 26% of the approximately 2300 investable stocks have - on a 12-month rolling basis - beaten the Larger-cap dominated TOPIX or Nikkei. Market Cap, it must be said, has been a nice contributor to performance, and for the Gaijin fund manager, this as much saved him for foreign portfolios are heavily skewed towards the both the megacap, and the merely large.

But what does it mean??!? To some extent it is reversing the large-cap underperformance that was the result of Daiko Henjo, and the opportunity that Cassandra highlighted in the waning hours of 2005. To another, it is that the wall of GCC money is ploughing into cap-weighted indices, and prime market leader assets. But it also reflects that domestic no-growth assets have few buyers, and it is these, by number predominate the Topix, and the equally-weighted ranks of "the average stock" universe. This leads to a fascinating potential struggle. The "good-stock/bad-stock quants will love to hate these stocks as they have little immediate appeal outside of under-catalysed under-valuation. But in a world where leverage is most plentiful, and trade buyers increasingly emboldened, and private equity on the prowl all over Kabuto-cho (and Roponggi), it will continue to be dangerous to be short of increasingly under-valued assets, however pathetic their cash-generating ability, and irrespective of how opposed entrenched management & their extended constituencies are to any change in the status quo. Steel Partners was the first ungainly shoots across the bow leading to a second round of more determined struggled BY JAPANESE inconoclasts for undervalued Japanese assets. 'Twill be entertaining to watch the ensuing scrum for the Japanese are not known for their Rugby prowess...

8 comments:

Anonymous said...

Still urrping from the Zrrping below, but to get right to it: Steel Partners? What did I miss?

I threw a few coins in the Japanese investment fountain recently, for the pedestrian reason that what is still will one day move. One thing that continues to mystify me is the varying reports on price inflation. Are they rising or not? Are consumers consuming or not?

Let's say the consumers there don't buy stuff, but as the Yen falls, that foreigners do. Seems to me that export oriented firms will do a little better despite home markets. What's the story? OldVet

Anonymous said...

I will be generous and grant that there are a few interesting situations which are trading below book value with a sizable chunk of cash.
As for the rest: If it looks like s**t and smells like s**t, it probably is s**t; and turning s**t into gold is one helluva a job....
Yes, at some price you can make money out of s**t. Shovels ready?

Anonymous said...

Yep, small shovel accounted for and ready to dig.

Latest GDP report says Japan up 4.8% in quarter. Yen wobbles. Who's lying? :) OldVet

"Cassandra" said...

Anon-

I've highlighted on a number of occasions that things are not always what they appear to be, best exemplified by the apparently low hanging fruit that was rotten since they all owned PEI bonds. But the global aspiration for assets makes Japanese assets simplly relativly more attractive - for 1/3 the universe (irrespective of growth) are near book have net earnings yields between 5 & 10% with cash yields higher than any money rate; a low Corp-GINI ratios and real asset values in a paper-glutted world.Admittedly they are beholden to wider constituencies, but that simply assures they wont be nationalized or taxed to oblivion as might happen in the US when the dispossesed go on rampage against globalization impacts...

Old Vet - Yes today's data shows that its bollocks that Japan should in any way shape or form be concerned about pernicious deflation, irrespective of whether consumer goods prices are falling. It is smoke out the MoFs ass and should be ignored like the rhetoric of Radio Pyongyang. Midcaps in Japan are up nearly 20% since end of Nov when I declared them cheap cheap cheap. But the rub is that in YEN terms. The fact is for the USD investor, you've barely made a dime (or only a few percent.

For a laugh check out FJPNX Equity GPC on the Bloomberg website (Fidelity Japan Fund in USDs). It's flatlined. Whenever the YEN rallies, stocks fall and vice-versa. And today's little puke in the USD/YEN EUR/YEN is no different following the heady gains over the past few days. At some point , with some of the cheaper dregs, one will get both asset appreciation, and currency appreciation. I just cannot tell you when...

Anonymous said...

A S**t-shoveller's Reply

Exhibit A: 7703 Kawasumi Industries (or whatever it calls itself in English). Declared Interest: zilch. If anyone cares to do a proper numbers analysis, the company used to publish annual reports in English: www.kawasumi. jp

Summary: Over the last 5 years sales have flat-lined, operating profits have halved and there have been net losses in 2 years. Book value has flat-lined, too and the share price is more or less where it was 5 years ago, half book value, though in the interim it has risen to near book value (when copy-cats bought in after Steele Partners joined the share register?) before abruptly falling back (when Steele Partners sold out?). Forecast profits for this financial year would give a ROA of about 1%.

Even though the ROA is piss-poor even by Japanese standards, Kawasumi is pretty typical of small- and medium-sized enterprises which don't have international exposure. If Japan were a market economy either an asset-stripper or a competitor would have bought out Kawasumi long ago (merged the operations, sacked the workforce and flogged the redundant assets). As Cass has explained, Japanese enterprises have a wide constituency of interests, and as he hasn't explained, it's nigh impossible to sack a worker who hasn't committed a criminal offense, so there are some very real obstacles to realizing asset value. Thus, these corporate zombies stagger on and on and on eking out a marginal living, and incidentally contributing to the deflation that afflicts Japan because production capacity is seldom ever retired. As another aside, this is also the reason for ZIRP, because behind the well-known Japanese companies which are benefitting from global economic growth there is a vast hinterland of essentially domestic enterprises like Kawasumi (and don't forget the unlisted ones) which are trying to survive in an essentially stagnant economy (see below). Normalization of interest rates, say, around 2-3% would cause enormous economic and social upheaval which the iron triangle of Japanese politicians, businessmen and bureaucrats are naturally fearful of.

To OldVet: Real GDP growth 4.8%! My newspaper headline asks, "Is it for real?" because nobody feels much better off. My answer: No! Nominal GDP, the cash in your pocket GDP, which IMHO is a better measure for a low inflation economy, peaked in 1997 (or was it '98?) and has been flat-lining just above 500 trillion yen for the past several years. The latest figure, 512 t, doesn't indicate any great change.

I accept Cass' point about 1/3 the universe, but it is a 1/3 universe which would only appeal to investors in a world with nothing better to be had. Maybe when the Dow hits 30,000 (together with the Nikkei), people will go grubbing around for the small-fry......

Returning to Kawasumi: Is it s**t or gold? Your call!

Cassandra said...

Anon has raised some interesting points to be certain. Let me first declare my interests too. I and my entities own no Kawasumi, depsite Tweedy's 13% vote. I have in the past owned it, but cut and ran (unlike US elected officals).

7703 is clearly not gold, and probably closer to shit. Philosophically, however, everything has a price, a view shared by Tweedy and other less-than image-concious and discriminating investors. Everything Anon said holds true. It held true in 1996 when had one implemented a bottom fishing strategy, one would, en masse, probably not have recovered one's investment today, 11 years later. However, in 2001 & 2002. when I more boldy acquired such exposure selectively, outright gains have been spectacular, and even my zero-market exposure numbers have yielded most attractive risk/reward nums.

This has as more to do with the fact that there numerous nice enterprises with niche markets, global markets growth prospects also thrown away due to lack of interest. But as global attention focused on Japan, the focus simple index membership lifted many boats. Most of these have, by now been recognized, yet many remain attractive on various absolute and comparative criteria. Others like Kawasumi languish, and rightfully so. Eschewing buzzwords I will not employ the 'C'-word (catalyst), but so it will remain until a Greenmailer forces Kuraray to make it a consolidated, or wholly owned sub at still-take-under prices. And although it won't be a bad investment, neither will it be good. It won;t be bad because the Japanese (and I am being honest, not racist) are like Hasidics - they simply prefer for language culture hygiene and obligation purposes, to keep business in the family. They can "trust" other Japanese (well except for Chori and Ishihara Sangyo, and SMM & Mit Motor and errrr....ummmm...). So Kawasumi will retain its current sales, and its current fixed o/h burdens, and churn out a CFROI under cost of funds though since it doesn;t have to borrow funds, this is really an indication of poor financial management (providing there are no PEI bonds or Tobashi still tucked away), pedestrian vision (a lowly 2.5% R&D sales for a med co.), and a lotal utter disregard for shareholders and lack of understanding of what ZIRP is doing to their bountiful alledgedly cash-rich balance sheet. It is, to be blunt, despite offical declarations to the contrary, devaluing it, and the quicker they give it back, or buy-back their shares, the better.

Though skeptical in general, I would note several things contrary to Tokyo Style or FujiTV and other wagon-circling self-preservationary activities:

(1) T-Zone & J-Bridge & Nikko Principal willing to take strategic stakes in Japanese co.s, not for white knight purpose, but for monetary gain.

(2) Increasing MBO activity: Greenhouse, Skylark, AsahiTec, now Sunstar, and a couple of others I cannot recall offhand. The barbarians are here and circling, and while the Japanese may not let them get the assets they way Ross, TPG & Flowers managed to get them when there was panic, it will cause some more meaningful fights with meaningful discussions of value, and therein will be the discussion - and perhaps - the inclusion of constituencies.

(3) Real Bid activity - OK I still have my doubts about Steel, but Sapporo has assets and a brand and maybe they are at a level thats fair value, but having pushed it to fairvalue, they still must exit, and that requires someone lese to bid. This may be the path that focuses minds on the larger co.s

All this says to me, the scrum is upon us, and when it gets going, and everything is in play values on even the shittiest of zombified no-gro enterprise will be lifted (at least temporarily). The only caveat, as with my other calls, is that it is predicated upon the continued expansion of liquidity and diminished real global rate of interest - something that despite my rantings, I would not bet upon happening in the immediate future.

Anonymous said...

S**t-shoveller's Post Script

Getting carried away with too many asides, I forgot to ask: How many of your no-gro, par value, nice little earners would pass a BS beauty parade test of debt less than 1/3 equity?

And for the finals: Are there any left when you chuck out those that aren't raising the dividend this year?

(I really must change that disgusting moniker!)

"Cassandra" said...

at least 2/3 of the 1/3. A zombie is a zombie is a zombie and most construction cos fall out (before) anyways on investability grounds...