July 6, 2016

Dear Investor:

It’s not often that a national market trades at a price below its liquidation value, but that’s Japan today.

The yen’s appreciation in the wake of the Brexit—as investors sought safe haven currencies to replace the sickly pound—has sent Japanese stocks reeling to a level they rarely reach: a combined market capitalization which is less than their collective book value (otherwise known as shareholders equity), the value which remains after all liabilities have been subtracted from assets. This is the value an owner would get if the firm were taken private, liquidated and unwound.

When a stock is trading below book value, that means no value is being paid for any prospective growth in the equity in the company. Many legendary value investors, from Benjamin Graham in the 1930s to Marty Whitman in the 2000s, have made good money buying stocks at this depressed price.

As is always the case, there are plenty of sensible-sounding reasons for the low prices, among them some truly compelling concerns: the deflationary bias in Japan; underlying structural problems that prevent corporate takeover activity to unlock such value; the bubble in the yen which threatens exports; the demographic challenge of an aging population that decries immigration. All of these together would explain a lower price for Japanese stocks but not the great discount that exists today. US stocks, for example, are trading at 2.57 times book value, a huge premium that dwarfs the Japanese multiple.

Simply put, at this price Japan Inc. must merely survive to be a decent investment. To the extent it does any better, Japanese stocks should do very well.
To access the Japanese market, I have purchased the DXJ in client accounts—a well-diversified indexed basket of stocks (an ETF or exchange-traded fund) with 349 individual stocks, including such household names as Toyota, Canon, Nissan, and Panasonic.
The DXJ hedges the yen, which is a good thing, given the potential overvaluation of the Japanese currency vs. the dollar

The Japanese market will continue to struggle with numerous headwinds. But none of these should take away a solid eventual return as traders bid stocks back up above book value—to something like the 30% premium to book that has been the average over the past decade.

Like emerging market stocks and steel stocks, Japanese stocks comprise a pocket of clear value in a worldwide equity market that has become increasingly expensive, especially in the United States.

With best wishes for the coming quarter.