"Land" of the Rising Sun
02/11/2005 12:00 am EST
With the Nikkei having endured a bear market since 1990, it's not surprising that many are fearful of investing in Japan. One advisor willing to go against the tide is Elliott Gue. Here, he offers his analysis on why the land of the rising sun may just be starting to rise again.
"Many investors have not considered investing in Japan for a long time. That’s because it was in a bear market for a long time. Consider that in 1990, the Nikkei was trading at almost 40,000 and then dropped to under 8,000. That is a vicious collapse. The two main issues that held back the Japanese economy were property prices and debt. The banks had an awful lot of bad debt. And property values were declining. Obviously, the economy had its troubles, moving in and out of recession throughout the 1990s. But I believe that Japan is now actually moving beyond some of the problems that it had in the past.
"Traditionally, the Japanese had a system whereby banks acted as the center of an industry conglomerate, tending to lend, uneconomically, to the companies within that industry grouping. That worked for a period when the economy was expanding rapidly. But it later became a problem when many of these companies within these various conglomerate groups had troubles and eventually defaulted on their debt. The Japanese banks ended up holding this worthless debt.
"However, we’ve now gotten down to a point where a lot of the old-line companies that weren’t profitable have gone bankrupt, the government has helped the banks to write off a lot of these bad loans, and we have had a purging of the system. They’ve written off all this unserviceable debt and now they have a more firm base of loans outstanding and they are in much better shape. They’ve realized that the earlier lending was a bad idea, and they’ve purged the system.
"One manifestation of this situation was that the property market also dropped for about 15 years. At the height of the bubble it was estimated that the average house in Japan cost about 40 times the average annual salary. That’s a lifetime’s worth of earnings and that is totally unserviceable. Here in the US, even after a pretty big run in many markets, the ratio is more like 10 to 15 years of average earnings. Meanwhile, that bubble in Japanese real estate has now worked through the system and some property values are now down as much as 90% from the late 1980s. We’re now back to a realistic level for property.
"Yes, it is still relatively expensive in Tokyo, but a very interesting thing has happened. People in Japan have begun to buy real estate again. Nobody wanted to be stuck with real estate for a long time. Why hold an asset that is declining in value? The other thing was that a lot of this real estate was held by big Japanese corporations and they held the real estate as an asset, at the price they had paid for it. The government has since forced them to write the value of these assets down. That helped purge the last excess of bubble-level valuation out of the system.
"Today, I think the two areas that investors want to focus on for the recovery in Japan are the two areas that were hit worst by the long depression-like environment, which are banks and real estate companies. We follow a bi-annual s urvey done by the Japan Real Estate Institute that covers the value of the ‘highest-priced’ land available in Tokyo. Back in the 1980s, this land was appreciating by more than 8% every half year. However, by 1995, these values were declining almost 20% from one six-month period to the next. That’s a pretty drastic drop.
"Throughout the 2000-2002 period, it was still dropping by close to 5% per six-month period. But in March 2004, this index picked up 0.9%, half year over half year. In September 2004, it picked up 4%. This is pretty amazing. It had been 15 years since we have seen that happen in Japan. We are now seeing land values actually rise. And this rise is now starting to spread from the highest-priced properties, pretty evenly across all properties in Tokyo and other major cities in Japan. And I believe eventually this trend will soon start to trickle down into more rural areas.
"One of my favorite picks in Japan is Mistubishi-Tokyo Financial (MTF NYSE), a very large Japanese bank. The do pay a dividend. And they have probably gone the furthest among the Japanese banks in eliminating its bad debt and bad loans. On the property side, there’s a company Sekisui House (SKHSY Other OTC). The company builds, leases, and sells condominiums and homes in Japan. As the nation's largest homebuilder, Sekisui House sits at the heart of this real estate trend and stands to benefit from better pricing as it sells new homes. But, this is the early stages of a new bull market for Japanese real estate and the stock is still trading at a tiny fraction of the valuations it fetched back in the early and mid-1990s. Adding to the investment case, Sekisui has little debt and sports a nice 1.5% dividend yield."