Buying Japan at a Deep Discount

03/30/2009 9:08 am EST

Focus: GLOBAL

Andrew McHattie

Editor, Investment Trust Newsletter

Andrew McHattie, editor of the Investment Trust Newsletter, is watching Japan with a hopeful but wary eye.

Last year, the financial maelstrom which has subsequently whacked markets had barely begun. Since that time the FTSE 100 Index has dropped by 36.7% and the FTSE All-World Index by 50.0%.

Outside of the US, the other major market most hotly tipped for a strong recovery at some point in the near future is Japan. There has been a lot of comment about the depths of the Nikkei’s decline, which recently retested and broke through its 2003 lows. It has been chilling to read about the Nikkei hitting 26-year lows.

There have been some suggestions, though, that the Japanese government could step in with new measures to help stock prices, particularly as shares have been trading below their book value (the accounting value of their assets). Putting this way, these companies would fetch more if they were all dissolved. Earnings are low in Japan, though.

We think that any investment in Japan now must come with a few caveats. Heavily dependent on exports, the Japanese economy has been hit very hard already by the recession, and it is not clear what horrors there might be still to come. A 4% fall in GDP is forecast for 2009. To add to the undoubtedly difficult economic conditions, Japan has some political issues to contend with as well. It’s a tough, tough environment for shares.

An article in The Economist magazine a fortnight ago summarized some of the main challenges: “Corporate profits have collapsed—down 89% on last year. Big manufacturers’ output is down by 20-40%. Toyota (NYSE: TM) has halved its output. Bellwether companies from NEC to Nissan have slashed jobs and investment. Industrial output is expected to fall to levels not seen since the 1980s.”

Against this background, we think it takes a brave soul to bet on a quick recovery, although, of course, a lot can change over 12 months. With the Nikkei around 8000, we understand that Japanese equities are already discounting a lot of bad news, and we quite like Schroder Japan Growth Fund (LSE: SJG.L) on a discount of 19.5%. At 56 pence, down from 77 pence a year ago, we think the shares might have plenty of fluctuation ahead, but we would be surprised if they were not higher in a year’s time. We suspect that because of its abysmal record, many investors may not have any exposure to Japan in their portfolios.

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