Investor Confidence In Japan Slides

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Japanese equities have traded at cheap valuation multiples for two decades, and for about the same amount of time value investors have been eyeing these stocks. Though they trade at attractive price-to-book multiples, Japan also faces special macroeconomic challenges that should dampen the enthusiasm of U.S. Investors. In light of Japan’s challenges, are there any Japanese stocks that shrewd investors should buy?

Record Low Confidence

Japanese manufacturer confidence has dropped to a record low level for the past three years. The pessimism can be attributed partly to the diplomatic dispute between Japan and China and problems in Europe, both caused exports to decline greatly. The Tankan index that estimates the confidence level has been very negative for the last few quarters and that is an indicator of increased pessimism. Daiichi Life Research Institute Chief Economist Hideo Kumano indicated that the results of the general election are also expected to impact the economy. According to Kumano, “The focus is on whether the economy will show any improvement after the election.”

Monetary Policy Between a Rock and a Hard Place

The Japanese Yen has greatly weakened against the Dollar. A weak currency for Japan means the country can offer lower prices for their products in the world markets. The country may also benefit from repatriated earnings from international firms like Toyota since its foreign currency earnings have higher value when the Yen is weak.

However, monetary easing to lower the exchange rate of the yen could result in domestic inflation. This is unacceptable, since Japan is the most indebted nation in the world. If the Japanese government has to pay higher interest rates, it may become caught in an inflationary/hyperinflationary spiral where higher interest costs lead to more money printing, which leads to inflation and higher interest rates, which leads to higher interest costs, and so forth.

Thus, the Bank of Japan will have to be careful with the policies it makes to prevent inflation. Amongst the arrangements that might be affected will be currency-swaps with central banks in England, Canada Switzerland and the Fed. Bank of Japan hopes to extend the swaps as it works to help the currency recover. UBS Senior Economist Takuji Aida analyzed the policy options of the Bank of Japan in a report. According to Aida, “If the BOJ opts to leave its monetary policy unchanged the yen could move back into the 70s against the dollar.” These concerns may no longer be valid given the recent fall of the yen.

If confidence increases in the coming quarters, the Tankan index should improve and that may also help the Yen better its position against the dollar.

Chinese Rivalry and Soft European Demand

Japan’s Gross Domestic Product has also been affected by territorial disputes with China. A consistently dropping Gross Domestic Product would technically mean that Japan was in recession. RBS Securities Japan Chief Economist Junko Nishioka however indicated that there was no cause for alarm since more orders for machinery were being received and there was increased production. According to Nishioka, “The recession will be short and shallow.”

Shipments and exports to the European Union have also faced declines. Sales of Toyota (NYSE: TM) are not doing well either, thanks to the territorial dispute between Japan and China. Sharp (NASDAQOTH: SHCAY), Sony (NYSE: SNE) and Panasonic (NASDAQOTH: PCRFY) are expected to lay off more than 29,000 employees combined as the government prepares to bail out Reneseas. Manufacturers and economists are however hopeful that the Japanese economy will improve.

Japan’s Financial Institutions

Institutional selling is a very real threat in Japan. Japanese megabanks may worsen price declines because they may be required to sell holdings in tough times in order to maintain capital requirements.

The combined losses of Japan’s Sumitomo, Mitsubishi, and Mizuho more than tripled compared to the figures from the same period last year. Mizuho is making efforts to reduce its holdings in other companies. Research Koji Haji, said, “Megabanks should carefully and gradually cut their shareholdings to mitigate fluctuation risks and further stabilize their management.” In addition, he stated, “If they rush to sell them off, they’d see an adverse impact on Japan’s economy as a whole and further weaken lending demand.”

Discounts to Book Value

As investors, we should try to find cheap stocks whose relative values justify jumping into such environments. There are many Japanese stocks whose price-to-book ratios are attractive:

<table> <tbody> <tr> <td> <p><span>Ticker</span></p> </td> <td> <p><span>Company</span></p> </td> <td> <p><span>Industry</span></p> </td> <td> <p><span>P/E</span></p> </td> <td> <p><span>P/S</span></p> </td> <td> <p><span>P/B</span></p> </td> </tr> <tr> <td> <p><span>SNE</span></p> </td> <td> <p><span>Sony</span></p> </td> <td> <p><span>Electronic Equipment</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.15</span></p> </td> <td> <p><span>0.51</span></p> </td> </tr> <tr> <td> <p><span>NTT</span></p> </td> <td> <p><span>Nippon Telegraph & Telephone</span></p> </td> <td> <p><span>Telecom Services - Foreign</span></p> </td> <td> <p><span>9.63</span></p> </td> <td> <p><span>0.45</span></p> </td> <td> <p><span>0.54</span></p> </td> </tr> <tr> <td> <p><span>NMR</span></p> </td> <td> <p><span>Nomura Holdings</span></p> </td> <td> <p><span>Investment Brokerage - National</span></p> </td> <td> <p><span>42.57</span></p> </td> <td> <p><span>1.01</span></p> </td> <td> <p><span>0.9</span></p> </td> </tr> <tr> <td> <p><span>MTU</span></p> </td> <td> <p><span>Mitsubishi UFJ Financial</span></p> </td> <td> <p><span>Money Center Banks</span></p> </td> <td> <p><span>137.5</span></p> </td> <td> <p><span>2.56</span></p> </td> <td> <p><span>0.79</span></p> </td> </tr> <tr> <td> <p><span>IX</span></p> </td> <td> <p><span>ORIX</span></p> </td> <td> <p><span>Credit Services</span></p> </td> <td> <p><span>12.76</span></p> </td> <td> <p><span>1.07</span></p> </td> <td> <p><span>0.74</span></p> </td> </tr> <tr> <td> <p><span>MFG</span></p> </td> <td> <p><span>Mizuho Financial</span></p> </td> <td> <p><span>Foreign Regional Banks</span></p> </td> <td> <p><span>5.89</span></p> </td> <td> <p><span>2.68</span></p> </td> <td> <p><span>0.84</span></p> </td> </tr> <tr> <td> <p><span>SMFG</span></p> </td> <td> <p><span>Sumitomo Mitsui Financial</span></p> </td> <td> <p><span>Foreign Regional Banks</span></p> </td> <td> <p><span>10.15</span></p> </td> <td> <p><span>2.74</span></p> </td> <td> <p><span>0.83</span></p> </td> </tr> <tr> <td> <p><span>PC</span></p> </td> <td> <p><span>Panasonic</span></p> </td> <td> <p><span>Electronic Equipment</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.17</span></p> </td> <td> <p><span>1.04</span></p> </td> </tr> <tr> <td> <p><span>MITSY</span></p> </td> <td> <p><span>Mitsui & Co.</span></p> </td> <td> <p><span>Conglomerates</span></p> </td> <td> <p><span>6.84</span></p> </td> <td> <p><span>0.51</span></p> </td> <td> <p><span>1</span></p> </td> </tr> <tr> <td> <p><span>KYO</span></p> </td> <td> <p><span>Kyocera</span></p> </td> <td> <p><span>Diversified Electronics</span></p> </td> <td> <p><span>25.15</span></p> </td> <td> <p><span>1.27</span></p> </td> <td> <p><span>0.96</span></p> </td> </tr> <tr> <td> <p><span>DCM</span></p> </td> <td> <p><span>NTT DOCOMO</span></p> </td> <td> <p><span>Telecom Services - Foreign</span></p> </td> <td> <p><span>11.52</span></p> </td> <td> <p><span>1.26</span></p> </td> <td> <p><span>0.97</span></p> </td> </tr> <tr> <td> <p><span>TM</span></p> </td> <td> <p><span>Toyota Motor</span></p> </td> <td> <p><span>Auto Manufacturers - Major</span></p> </td> <td> <p><span>17.67</span></p> </td> <td> <p><span>0.67</span></p> </td> <td> <p><span>1.21</span></p> </td> </tr> <tr> <td> <p><span>HMC</span></p> </td> <td> <p><span>Honda Motor</span></p> </td> <td> <p><span>Auto Manufacturers - Major</span></p> </td> <td> <p><span>17.56</span></p> </td> <td> <p><span>0.65</span></p> </td> <td> <p><span>1.3</span></p> </td> </tr> <tr> <td> <p><span>KNM</span></p> </td> <td> <p><span>Konami</span></p> </td> <td> <p><span>Multimedia & Graphics Software</span></p> </td> <td> <p><span>14.2</span></p> </td> <td> <p><span>1.09</span></p> </td> <td> <p><span>1.18</span></p> </td> </tr> <tr> <td> <p><span>NSANY</span></p> </td> <td> <p><span>Nissan Motor</span></p> </td> <td> <p><span>Auto Manufacturers - Major</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>1.4</span></p> </td> </tr> <tr> <td> <p><span>CAJ</span></p> </td> <td> <p><span>Canon</span></p> </td> <td> <p><span>Photographic Equipment & Supplies</span></p> </td> <td> <p><span>17.84</span></p> </td> <td> <p><span>1.29</span></p> </td> <td> <p><span>1.57</span></p> </td> </tr> <tr> <td> <p><span>MKTAY</span></p> </td> <td> <p><span>Makita</span></p> </td> <td> <p><span>Small Tools & Accessories</span></p> </td> <td> <p><span>17.55</span></p> </td> <td> <p><span>1.92</span></p> </td> <td> <p><span>1.7</span></p> </td> </tr> <tr> <td> <p><span>KUB</span></p> </td> <td> <p><span>Kubota</span></p> </td> <td> <p><span>Diversified Machinery</span></p> </td> <td> <p><span>20.96</span></p> </td> <td> <p><span>1.26</span></p> </td> <td> <p><span>1.87</span></p> </td> </tr> <tr> <td> <p><span>NJ</span></p> </td> <td> <p><span>Nidec</span></p> </td> <td> <p><span>Industrial Electrical Equipment</span></p> </td> <td> <p><span>14.04</span></p> </td> <td> <p><span>1.1</span></p> </td> <td> <p><span>1.95</span></p> </td> </tr> </tbody> </table>

The only stocks on this list whose valuations justify braving Japan are Sony and Nippon Telegraph & Telephone (NTT). These companies trade at a roughly 50% discount to book value, and they are cheap for their industries. Each should be researched further as a potential buy candidate.

There is no reason whatsoever to become involved with Japanese financial companies since there are banks trading at similar discounts to book value in the U.S.

BillEdson11 has no position in any stocks mentioned. The Motley Fool is short Sony (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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