After the earthquake and tsunami struck Japan, markets sank throughout Asia. Investors worried that the devastation would disrupt power producers and hurt a wide range of manufacturers.
But some money managers argue that the pessimism is excessive. While the damage was enormous in some parts of Japan, the country should rebuild soon enough. Many Japanese companies remain global powerhouses that will continue to benefit from growing emerging markets. “The long-term effects of the disaster are not likely to be significant,” says Edward Gray, portfolio manager of Delaware International Value Fund.
Even before the March devastation, some analysts believed that Japanese stocks were cheap. For years, the Tokyo markets had been on a long-term downward trend. The Nikkei Index hit its all-time peak of 38,900 in 1989. At the time, Japanese manufacturers were booming, and real estate in Tokyo was the most expensive in the world. Many Americans worried that Japan would become the dominant economic power. Then the Japanese bubble burst. Real estate prices collapsed, and banks were saddled with bad loans. The Nikkei sank steadily, hitting 9000 in 2002 and 7,000 in 2009. Lately the market has rebounded, topping 10,000.
Analysts blame the sluggish market on a host of problems. Some portfolio managers say that regulators have failed to pressure banks to clean up their balance sheets. More importantly, Japan faces long-term demographic problems. Because the country has small families and discourages immigration, there is no population growth. With the population aging, there are fewer workers to support retirees. All that is slowing economic growth to a crawl.
Which stocks are best?
To avoid companies with lackluster growth, some portfolio managers suggest sticking with stocks that export to the booming emerging markets. The auto companies are especially appealing, says Sarah Ketterer, portfolio manager of Causeway International Value. After the earthquake, the auto shares plummeted as investors worried about supply disruptions. The fears are partly justified, Ketterer concedes. Earnings will be hurt for several quarters she says. Domestic Japanese sales, which have been sluggish, will fall even further as the country rebuilds. But the problems should end soon. “The parts shortages are only temporary,” says Ketterer.
Weak sales in Japan should be outweighed by growth in overseas markets. Ketterer particularly likes Honda. Less than 15% of the company’s sales come from Japan. “Honda is particularly interesting because it has a rapidly growing motorcycle business in Southeast Asia and Latin America,” she says.
Of the Japanese automakers, one of the cheapest is Toyota, says Edward Gray of Delaware International Value. The automaker sells for less than its book value, a low price at a time when the stocks of the S&P 500 sell for twice their book value. Toyota’s shares sank in 2009 and 2010 as the company announced embarrassing recalls. Investors began to question whether Toyota still deserved its reputation for being a global leader for quality manufacturing. But the company will get back on track, says Gray. “Their attention is focused on fixing the problems, and they have the resources to get the job done,” he says.
Another industry Ketterer likes is life insurance. The insurance stocks sank as investors worried that deaths during the disaster would boost the cost of claims. But the life insurance companies suffered little damage because the number of deaths represented a small percentage of the total population. Ketterer says that the aftermath of the earthquake should create positive conditions for insurers.
To pay for reconstruction, the Japanese government will have to spend a total of around $300 billion. Tokyo will finance the cost by selling bonds. To attract investors, the yields on bonds will have to rise. That will help life insurers. The insurance companies collect premiums and invest much of the cash in bonds. When yields rise, the insurers collect more income.
Ketterer’s favorite insurer is Sony Financial. Besides providing life insurance, the company also sells supplemental medical coverage. As the population ages and the country runs increasing budget deficits, more individuals are likely to buy their own coverage instead of relying on government programs, Ketterer figures. “Supplemental health products are profitable, and they should become more popular,” she says.
Investing in reconstruction
Some investors have been racing to buy Japanese engineering and construction companies, which stand to benefit from the rebuilding. But Ketterer says that it is too late to join the crowd. Prices have already climbed. She says that investors could be disappointed by the performance of the stocks because of the difficulty of financing and completing the massive reconstruction effort. Instead of enjoying a boom, construction companies are likely to experience muted growth that will be dragged out for years.
Investors who prefer a mutual fund should consider Matthews Asia Pacific Investor, which has 34% of its assets in Japan. During the past five years, the fund has returned 7.5% annually, outdoing 99% of its peers. Portfolio manager Taizo Ishida looks for stocks that have modest prices and healthy long-term growth prospects.
Automation and Internet holdings
Despite all the problems Japan faces, some companies are reporting strong sales, says Ishida. He particularly likes Fanuc, a producer of robots and equipment used to automate factories. About one third of the company’s sales come from China. Customers include fast-growing Chinese auto makers, says Ishida. “Wages are rising in China, so the companies are buying new machines that can cut costs,” he says.
Ishida also likes Softbank, which operates Internet search engines. Japanese consumers may be cautious, but Internet traffic continues to increase.