The Value Of Good Times Revisited

My first year on this planet was the first for humanity on the moon. A good year but no memory of it. Probably my earliest happiest memory was lying on the floor playing with Airfix toy soldiers in a Waterloo battle scene at Christmas time as Simon & Garfunkel’s ‘The Boxer’ played on my parents’ hi-fi. Happy times, and always grateful for plenty more over the following decades. However, last week another ‘good times’ feeling was prompted by the radio belting out “The Boxer”, quickly followed by a news update on another lunar expedition. Yep, it was Japan’s turn to visit the moon but also a reminder of how much I loved living in Tokyo in the ‘90s. Good years, many memories. I won’t be visiting there any time soon but the memory-jog from the East could be timely. Japan might just be about to revisit its own good times…..

The main stock market index in Tokyo, the Nikkei 225, recovered to a 34-year high this week. That’s a positive headline but doesn’t escape the fact that the Japanese stock market has only returned to index levels last seen when I first landed in Japan. However, there’s a lot more going on than headlines highlighting 34-years of zero wealth creation. In fact, I’d almost use the word ‘progress’. Progress might not sound like a big deal to readers, and I might have shared that very same view until I came across a fascinating piece of data in the Financial Times(FT) in recent weeks. Thanks to the Google AI tool, Ngram Viewer, one can explore language usage trends over time by searching millions of books, documents and other text sources.

According to the FT’s John Burn-Murdoch, usage in the West of English, French and German words for “progress, advance, future, rise and improvement” have been in decline since a few years after Apollo 11’s daring touch-down on the moon. Meanwhile, usage of the words for “threat, worry, caution, risk and caution” have increased significantly to suggest a multi-decade cultural shift to risk-aversion, or ‘safetyism’ which is being used a lot these days in AI discussions. Indeed, a recent excellent David McWilliams podcast with Burn-Murdoch explored this potential connection between culture, language and growth. For Japan, this analysis must genuinely resonate. After decades of trying to unwind huge debt levels in its financial system, and persuade its ageing population to spend, there are interesting developments which point to a significant cultural shift.

Leaving aside the ambition to be only the 5^th nation in history to successfully ‘soft’ land on the moon, Japan is flexing its ‘progress’ and ‘advance’ muscles further afield. How about the daring move by Nippon Steel last September to buy iconic US industrial asset, US Steel, for $14 billion? Or Softbank swooping for Ireland’s Cubic Telecom in a €473m deal pre-Christmas? Perhaps the even bigger deal is the incoming capital landing on the island nation. Last April we wrote about Warren Buffett buying up significant stakes in Japanese sogo shosha, 150-year old industrial trading houses, described by Buffett himself as “a cross-section of not only Japan, but of the world”. In some ways, Japan is the beneficiary of a global China de-coupling. Indeed, its trading houses could be considered a new de-risked staging post to access the Asian middle-class; a cohort which will account for a stunning two thirds of the global total by 2030. And….Buffett is not the only financial guru revisiting Japan.

Steve Cohen, has opened a Tokyo office of his Point72 hedge fund and US private equity player, Ares Management, has announced plans to do the same in 2024. Ken Griffin’s Citadel, the most successful hedge fund in history, has also decided to reopen its Japan office. So what’s the deal? Well, when an iconic Japanese industrial giant like Toshiba agreed in September 2023 to a $14 billion sale to local private equity firm, Japan Industrial Partners (JIP), that was a very big deal. Not the size, but the business cultural signal. Typically, underperforming companies on the Japanese market have stubbornly rebuffed shareholders’ demands for maximizing returns on invested capital. In fact, the Japanese authorities have frowned upon the unfettered threat of Anglo-Saxon-style unsolicited takeover bids. Without the threat of takeovers, Japanese companies, in aggregate, have displayed the following unique features:

Japan’s listed companies sit on enormous cash piles amounting to almost 45% of their market capitalization. That’s about three times what UK or US companies hold (Source: IMF)
Prior to Covid-19, Bloomberg reported that total cash held by Japanese companies on their balance sheets had reached 90% of Japan’s $5 trillion GDP.
40% of companies listed on the Tokyo Stock Exchange finished 2022 with net cash holdings equal to more than 20% of their equity. (Source: Carlyle)
50% of companies listed in Japan are trading below the value of the assets on their balance sheets. In financial valuation terms this is expressed as a price-to-book ratio of less than 1x. (Source: Schroders)

So, cash is king. But, in a super-low interest rate Japan, un-deployed cash is killing investment returns. This is reflected in so many companies trading on valuation multiples less than 1x price-to-book, but is now poised for a shake-up. The Tokyo Stock Exchange (TSE) has formally instructed all listed companies whose price-to-book ratio is less than 1x to raise their multiple above 1x, or risk being de-listed. One way to do that is to reduce the book value in the ratio by handing cash back to shareholders. The TSE has published a “name and shame” list and this is raising investor expectations of better governance and deployment of capital. In fact, more than 50% of Japanese companies have increased their cash dividends to shareholders in the last year. Sounds like Warren, Ken and Steve have their eyes on the ball. And, if you like ball games, then Japan is making waves there too..

Shohei Otani from Iwate Prefecture has just signed a $700 million contract with the Los Angeles Dodgers baseball franchise. This is the biggest individual contract signed in history, in any sport, and it feels like ‘a moment’ for Japan. I sense other moments too. Tokyo’s stock exchange has just passed out Shanghai in market value and regained its place as Asia’s biggest equity market. And, it’s not just investment capital coming to Japan. Back in the mid-1990s tourist numbers were just over 3 million. That number had rocketed to over 30 million before Covid struck. Anecdotally, Japan seems to be on so many ‘bucket lists’ as the last advanced economy which is truly a different experience for travellers. Also, thanks to its price stagnation problem over the last 30-years Japan is presenting far better relative value attractions than its “pricy” reputation. Of course, value is a huge factor in financial markets so my final Japan revelation might surprise.

We mentioned earlier that Japan’s stock market has only just returned to levels last seen in 1990. In other words, the long-run multi-decade returns on Japanese assets (on average) have been close to zero. However, the annual valuation “bible” published by Nobel Prize winner, Eugene Fama, and Kenneth French has just thrown up an amazing bit of data. Japanese stocks which qualify as value stocks (low valuation ratios like Price-Earnings, Price-Book etc) have compounded returns at 6.5% annually in the period 1990 to 2022. In a global market recently dominated by Big Tech and “Magnificent Seven” turbo-charged valuations and share price gains this is a timely reminder of Warren Buffett’s super-power, TIME, and his focus on value for long-run returns. For investors today, the investment question should always address value but also… timing. Right now, watching these moments, I’m wondering is it Japan’s time for good times again? It certainly has a fighting chance.