1. The question is:

“I got a good run up in ISJP and was stopped out yesterday-in at 14.23 in august 2012 and out yesterday at 17.

I am sure many would appreciate a view right now on PBV on Japan smallcaps.”

I cannot give you specific stock details anymore, and I am generally anti-ETFs. This is because, firstly you cannot select what you are buying, and secondly, you cannot feel the joy of owning cheap stocks.

My view is that P/BV of small companies in Japan is on the whole good, but in places outrageously good. I also think that this is a long-run bull market, and small companies will do better than large ones for several reasons, the best of them being valuation and liquidity as share prices rise.

If you are serious, I would recommend opening a brokerage account where you can trade small Japanese stocks, bidding for some which are really cheap, and then just sit and wait a long while.

There are long-term forces at play, including the yen – cheapening the currency does not have an immediate positive impact on a country (it takes time for businesses to shift preferences, exports do pick up in the short term, but the negative impact of increased import prices tends to be greater at first), including increasing retail investment, more wasteful spending by the government, inflation starting to move in the right direction, many companies benefiting from growth in SE Asia, and lots of little things going slightly better. On a historical view (spanning c. 200 years) Japan tends to move in the same direction until it hits a hard object, such as deflation or the black ships of America, and then it undergoes fairly rapid change. Also, for most investors, it appears to have so far been a “trade” on yen weakness only, and that is likely to change into a more nuanced view, in my opinion.

Further, just think about this – Japan is the third largest economy in the world, has more listed stocks than the UK, France, and Germany combined, and yet nobody is genuinely interested in investing in it still, and its markets are very inefficient. I do not think this will last for ever.

Every so often I find I need to re-read this passage of Reminiscences, the first book I ever read about the stock market:

“No! No! I can’t do that!”

“What?” yelled Elmer.

“I simply can’t!” said Mr. Partridge. He was in great trouble.

“Didn’t I give you the tip to buy it?”

“You did, Mr. Harwood, and I am very grateful to you. Indeed, I am, sir. But ”

“Hold on! Let me talk! And didn’t that stock go op seven points in ten days? Didn’t it?”

“It did, and I am much obliged to you, my dear boy. But I couldn’t think of selling that stock.”

“You couldn’t?” asked Elmer, beginning to look doubtful himself. It is a habit with most tip givers to be tip takers.

“No, I couldn’t.”

“Why not?” And Elmer drew nearer.

“Why, this is a bull market!” The old fellow said it as though he had given a long and detailed explanation.

“That’s all right,” said Elmer, looking angry because of his disappointment. “I know this is a bull market as well as you do. But you’d better slip them that stock of yours and buy it back on the reaction. You might as well reduce the cost to yourself.”

“My dear boy,” said old Partridge, in great distress “my dear boy, if I sold that stock now I’d lose my position; and then where would I be?”

2. What is the mystery country?

It is Vietnam. The valuations of many stocks have run up quickly, and if you are managing hundreds of millions then it is getting harder to find any room below the foreign ownership limits. But, there are still some really great valuations there.

In fact, foreign individual investors visit brokerages quite rarely.

When I went to set up my account, not only did they treat me like royalty, but a journalist was there to record the story!

And I appeared on two Vietnamese finance websites.

Here is a picture of me on a Vietnamese website getting excited about net current asset value:

http://m.tuoitre.vn/tin-tuc/Kinh-te/Kinh-te/1059650515,Chung-khoan-trai-chieu-nha-dau-tu-lac-quan.ttm

http://vietstock.vn/2014/02/nhip-dap-thi-truong-0602-vn-index-do-nhung-tam-ly-nha-dau-tu-van-tich-cuc-1636-330770.htm

Where else in the world would this happen?

3. My updated macro view and new forecast

My new macro view is summarized by this:

Here is my new forecast:

Great fortune lies ahead, but the seeker of wealth should tread carefully, for prosperity shall not be achieved without certain reversals

Here is another prediction:

You have certain anxieties about your finances. Do not worry, they shall improve with time.

4. The benefits of going too far

In my last post I mentioned that I was very cautious and that I was short the PLN against the USD. This position quickly moved against me, and I had to reevaluate my understanding of the world at that point, which I found flawed, and reversed my position by closing out most shorts and buying some stocks. The reason I could do this is due to the psychological thorn in my side of the PLN short – without it I would not have brought my mind to concentrate on the problem so clearly. I have still kept shorts in the most outrageous US stocks (internet-related), but closed the others.

Meanwhile, another tool I find very useful is to place bids way under the current market price. Sometimes I trim marginal positions if necessary, and bid to buy them back if they fall enough. When I start getting emails from my broker saying that I got filled on these low bids, it is usually time to start buying some more. This is a very helpful technique in that it takes a lot of the difficult psychology out of buying and selling in a rapid market. Do not do this for core positions, meaning stocks that you are anticipating to hold through a full bear market.

Some forecasts, notes, observations, and high-conviction forecasts

High-conviction forecasts:

1. Many shall be restored that are now fallen and many shall fall that are now in honour

2. The predictions spouted throughout the general media shall be proven to be shortsighted

3. Nobody today has any clue about what the world will look like in five years’ time

4. But, within the next five years, there will be attractive valuations again seen in a developed economy stock markets

Observations/ notes:

1. Stock prices are still too high, especially in the US and in Europe. Value still exists in Japan. This is why I am hedging Japan value positions with short positions in the US. We have had a modest move downwards in prices, but given valuations, expectations, bullishness, and unusual interest rates and corporate margins, this recent sell-off is nothing yet, in my view.

2. I believe that it is sensible to use currencies as part of a hedging programme. I have been fortunate in picking up on the Turkish lira story early on. I am now wondering what is the possibility of a reflexive downward spiral in the Polish zloty. The country recently robbed investors, and needs to roll over some debt soon. Inflation is low and falling, and interest rates could be lowered, but I suspect not raised without a crisis. The current account is not great, and the currency is hardly a go-to store of value. At any rate, I see the risk of a great appreciation here to be low, and I have started to sell the currency short while observing the situation. I have been also borrowing GBP to buy JPY, for reasons I have written about before.

3. There is one country in Asia I am going to on Tuesday, in order to open a brokerage account in, and I am very positive about the prospects for their stock market. More details later.

4. My general feeling is that events are forcing interest rate movements upon the markets, despite the best efforts of politicians and non-elected individuals in suits. Turkey has been forced to raise interest rates, and will nonetheless need a cheaper currency going forwards anyway. The same dynamic is happening in other vulnerable countries. If the same thing happens elsewhere (which I think it is perhaps reasonable to anticipate and speculate on), one would be advised to carefully observe low-quality fixed income firstly in peripheral economies and then in the US and Europe (both corporate and junky-national). I think the problem can be summarised thus: low interest rates give rise to high interest rates – although not in the borrowing stimulation -> increased capacity utilisation -> inflation route, but rather that of excess yield chasing -> increased system fragility -> sudden falls in yielding assets triggering more falls in yielding assets. As an aside, is anyone else out there fed up yet with the blanket use of the term “emerging” markets? When will we start to say “submerging” for e.g. Turkey? What has Russia got in common with India (other than a falling currency and as a shortcut for lazy journalists)?

5. Corn is apparently below the cost of production. It is interesting, because many US farmers are flush with cash and not yet desperate, and little of the 2014 crop has been sold. Sugar is too, but that is a messed-up market you do not want to get involved in. Also, chicken prices in Pakistan are below the cost of production, while those in the US are high.

JP

Ok, so let’s say that you walking down Ratchadamri in Bangkok, looking for some juicy grilled chicken. You come across five grilled chicken stands in a row. Customers view the chicken stands in the same sequence, from 1 to 5, but do not necessarily view all five chicken stands before making a purchase. If you were to be a chicken vendor, which position would you select for your chicken grilling business? Assume that all of them have equal quality chicken and at an equal price. Write a number between one and five using your index finger on the table. This will embed your selection in your memory and prevent you from backtracking and changing your mind.

Do it.

Now.

Now, before I tell you the answer (or my answer, which may or may not be right according to someone else’s version of game theory), I have to tell you that, for reasons which I may or may not wish to discuss here, it appears that I will soon no longer be writing up specific stocks on this blog. I will probably write from time to time about how it feels to be the only person shorting the US market and about my fascination with the Turkish lira, while somehow tying this all into Japan.

Also, I was going to write up one Japanese accounting software stock here, but I think I need to increase my position before I do that. If I were you, I would look into Japanese accounting software stocks.

The answer to the question, is that it is a trick question. If the going price of grilled chicken legs in Bangkok is 50 B, and if the first chicken stand that customers come across has chicken at 30 B (as do the other four), then they will likely quickly go for the first one, assuming it is a great bargain in the belief that the value of shopping around is low.  If you selected the first one but did not anticipate this, then that means your selection was probably based on a mental bias not grounded in anything in particular.

If, on the other hand, the going price in Bangkok is 50 B whereas the chicken stands are all at 70 B, then punters will not stop at the first stand, will check the second stand, find that the price of the same but still feel that it is expensive, go to a third stand find that it is still the same, and then assume that it is a standard and buy from the third stand. Some people will be stubborn enough to go to the fourth stand, and a smaller proportion until the fifth; however, if the price is extremely high (say, 120 B), then most people will go to the fifth stand.

P.S.: If anyone has Harold Schulz’s direct number, please let him know that we got the message about Christmas etc. and he can dial down the seasonal flavour a bit and we will still buy his coffee.

Firstly, I was away in Europe, mainly focusing on eating in E.Europe and Italy. I wasn’t looking at the market since I sold down massively in May – near the top, even though my constant jibber-jabber about shorting did not materialize.

I came back to Japan, and sitting in the onsen regularly has got me thinking that ultimately I am managing defensively, which right now means that I need to get back almost fully long equities in Japan, even though the US market makes me sick.  Let me explain.

The biggest risk I can see to me here is a big decline in the yen. I was wrong about the yen since the summer.  My thinking has changed.

I still believe that a weak yen will most likely ultimately lead to a strong yen (with a few years, not decades, since on the decades scale there is the population issue). This is because a weakening yen is essentially a mercantilist policy to improve imports at the expense of purchasing power of regular folks, and it increases the current account, which … increases demand for the yen. Even if China and Korea do not retaliate, there are too many countries wanting to do the same thing as Japan. I still think that eventually, one day, when the US market has a down day of more than trivial magnitude, the reaction in the yen will be significant.

However, there is also the risk that we are in a kind of late-cycle ramp like we saw last time, whereby capital-goods exposed investments (like Japan) and those with high operating leverage (like Japan) get bid based on any sign of improving utilization.

Now, considering that the stocks I am buying in Japan are great deals any way you look at them, there is a serious chance of some of these really running away – unlike in the US, where nothing is attractive at current prices, and where I don’t care about sitting mainly in cash and buying occasional puts.

For instance, I am seriously bummed that Japan Materials has run away while my position in it was cut, Tasaki has being running away from me, and 日信電子サービス  has just been taken over (not much of a surprise) after I halved my stake in it, completely stupidly, earlier in the year. But, there are still many bargains out there.

That is what it boils down to, and if I had been writing regularly I would have discussed the way that Abenomics is ultimately doomed but is now looking like second-round effects will get a look in. I would have talked about the softness in addressing structural issues, tinkering with marginal laws, creating unnecessary jobs and regulation to supposedly make business easier. Or the tax issue.

But I have come to the conclusion that not being in my favorite long-term names right now is a big risk. To my favorite names that have not run up excessively (such as Mizuno, Treasure Factory, Techno Medica, medical gas companies), I have been added a few such as Nintendo, which in fact has been running away during my buying, and am now revisiting some “high risk” names which have solid balance sheets and/or the potential to fly, such as Techno Math and Risk Monster.  I sold Billing System too early (who would’ve guessed) and missed out big time.

What I am /am not scared of:
I continue to think that the prospect of the Japanese government defaulting on obligations to its citizens in the next few years is highly unlikely. I keep on reading about how terrible Japanese debt is, but given that the protagonist (the JCB) can control interest rates and print indefinite money, the arguments going around about imminent Japanese default are like saying that a man must shoot himself in the head if he has a gun in his drawer -no he doesn’t as long as he is in possession of his senses and control over his trigger finger. Yet again, I repeat that the whole situation will result in inflation, but the picture is complicated by the current account surplus and the measures designed to increase it.
What does scare me, is the fact that Japan, as well as all other surplus countries, is trying to increase its surplus when it should be doing structural reform to fix the demand and productivity issues domestically. This is an echo from the US’s decision to not impose a burden on surplus countries when establishing the Bretton Woods system – for if there were penalties on surplus countries built into the system there would be pressure to resolve imbalances internally rather than beggaring neighbors. And, the way things stand at present, this inflexibility is guaranteed to result in another crash in which Japan, China and Korea will suffer badly. Despite this fear, the balance of probabilities and weightings according to my thinking leads me to err on the upper end of equity allocation in Japan right now.

Performance over the summer was essentially flat and in-line with the index, but who cares?

In other news, I seriously considered setting up a small fund, and found out that the running cost can be made minimal in the Seychelles, but decided against it. After just reading Taleb’s Antifragile, it is plain that not being 100% invested is not a good position to be in when going out and raising investment. But of course, when the market crashes, and after I will be 100% in, then no one will want to invest with me or anyone else.

The translation business is growing, but only partly from finance. I have been having trouble recruiting new people because my standards are too high. I have to hold myself back from saying “sorry dude, you’re crap” and reach back to corporate days to find the right “HR” words to tell candidates the truth – such as “you would be better suited to…” or “you have demonstrated potential, but…”.  Honestly, I never fail to get surprised by how many cowboys there are in translation. One potential hire, when confronted with my appraisal of his strengths, told me flat out “I’m a good translator, and just because you don’t think so, that’ just your opinion” – what a loser! Where is Japan’s Yamato damashi (Japanese fighting spirit)?.

Once I get some new capacity through new hires who are not crap, I will get round to expanding in the area of finance.

In the UK, I made some money by betting that Albemarle and Bond, which i wrote up on this site, would be worth over 17m GBP, and that its rival, HAT, is worth more than net-net value.

Meanwhile, I have only been half-heartedly shorting the US after my initial positions were decimated. Nonetheless, as things stand, other than holding on reluctantly in Japan, it currently looks like the next big opportunity for me will be on the short side in the US.

In other news, I have discovered some more great restaurants in Tokyo (steak lunch for c. $15, and the yen is supposed to be overvalued?), and got my first pair of custom-made shoes, in Poland. Now, I have an important appointment with a grilled chicken to attend to in Kamiyacho. Oh yeah, and Japan has better pizza on average than Italy.

I wrote the general update below on a train in Poland three weeks ago. Currently I am in Bratislava. Here is a koala san using my computer in my hotel:

Basically, not much is going on other than me gradually turning more bearish. Lack of value outside of Japan has just led to a general stoppage of value research on my part. Since I wrote the update below I have gotten even more bearish, and a few days ago I significantly reduced my Japanese stock longs (again – seems hyperactive, but I am only responding to what the market is telling me to do).

I have read some excellent commentaries in the last few weeks, giving me even less reason to write about anything. The one I recommend my readers to look at is the Hussman Weekly Commentary (google it) – although Mr. Hussman has been wrong for a while in this bull market, his general valuation framework is solid over long periods of time, empirically robust, and disciplined. The reason why he has been wrong, in my view, is that the stock markets are way overstretched. He thinks we are in the latter stages of a significant top in the market, and I happen to agree. The reason why I have become this bearish of late (and not earlier) is due to the additional factors of credit deterioration, which are evident in junk bonds, Chinese credit, and elsewhere; as well as increasing signs of market participation by retail dumb money and exiting by less-dumb money. I am now building a short position on various indices, and going long JPYUSD.

General update:
Firstly, let me say “thank you” to the “thank you’s” I have gotten recently.

My lack of communication is both a function of what is happening in the market and my own traveling in Europe right now – you do not want to be in the Japanese heat.

On several occasions I wrote half-finished articles, but decided that, upon reflection, I had little to say that was either important, interesting, or potentially profitable. The market (outside Japan, mainly) has frustrated me with high valuations, and I feel as if I am living in a strange world where the stock market does not exist.

Of course, if I have not mentioned it before, this blog is for my own purposes, to expose my failures and successes to public view, and force some discipline on my investment processes. The fact that a number of people have made nice returns based on my articles is great, but not what drives me.

I now have enough translation work for my company for the moment, so I will only be accepting limited new requests through this site.

Japan stock performance:
In hindsight, performance was good. I managed to sell down from c. 85 to 25 pc long exposure directly after the initial big fall in May, and then go up to about 85-90 pc just after the first big rally in June. I do not see myself as a market timer at all – I was simply reacting to incentives the market was giving me.  At the time I was killing myself for not shorting the Nikkei at the highs, despite my constant chit-chat about shorting soon. Nonetheless, I am now happy with the overall decisions taken in that period. (Aug 08 Update: exposure way down again on yen bullishness).

Current stance:
Japanese stocks: I currently expect that I will not do anything to my portfolio for the next couple of months.

General things:
The things I look at (valuations, sentiment, and general credit conditions) are all saying “sell”, if not yet screaming so. Selected Japanese names are the only island of reasonable valuation.

There appears to be a belief out there that QE makes stocks go up, but it may be that it is simply this belief itself that makes stocks go up … until, that is, there are no more greater fools available. Has anyone forgotten that bear markets tend to occur in easing environments?

I have started to short outside of Japan, still at levels that are not yet even heading my illiquid stocks, but I intend to increase short exposure, mainly in the US.

Gold: I was wrong. I now think that the price is likely to be higher in the next 12 to 24 months due to:
– the price of gold being close the cost of production (capex included)
– it seems that there is a connection between recent declines in the gold price with the reach for yield and/ or belief in ever-rising stock markets. I believe that this belief is self-fulfilling and reaching limits of its viability (primarily due to evidence of credit stress), and the above reach for yield is evidently getting stupid.
– there is abnormal behavior in the gold futures that indicates a lack of physical gold. This matches with premiums above US and European gold markets paid in Asia, as well as with anecdodal evidence of Asian demand.
– if the economy improves, inflation will go up – you already know this “bad is good” behavior
– if the economy deteriorates, earnings will have to go down
– US banks are now net long gold, and speculator short positions are at all-time highs

Of course, all of the above can continue for a while – longer than a rational person can remain solvent – but I think that the overvaluation in stocks, ridiculously low yields, apparent beginnings of credit stress, the age of the bull market in stocks, the high sentiment in stocks, the awful sentiment in gold, the low cost of gold when measured in terms of cost of production, and the inevitability of eventual inflation based on primary school maths and inputs on debt and output figures, make gold attractive here.

Sent with Writer.

Sent from my iPad

So on the way to the curry shop I stopped by a bookstore, and performed a quasi-scientific enquiry. The original hypothesis was that Japanese people are becoming less negative on stocks.

Of course, the sample size was small, so this is merely an observation, and does not even deserve to be called an enquiry.

The section dealing with stocks was small. In fact, it was significantly smaller than that on taxes. There were almost no books on Abenomics, but it appears that there has been a decrease in the number of titles proclaiming either the end of the world or the end of Japan.

My general impression was that the negativity was less than my previous observation.

However, I felt that it might be more interesting to check out another hypothesis, namely: Are Japanese people becoming bored with their jobs past the threshold where they openly want to break out of the Corporate-Socialist system?

The reason for this change hypothesis is that there was a “featured books” section dedicated to exactly this kind of book.

The kind of book I’m talking about is like this:

“Stop being a slave, now that you’re in your 30s” (about how “common sense”, which I guess means the Japanese elaborate system of unwritten rules, is robbing you of your freedom)

“The psychology of people who don’t think about anything and just let things happen” (written by a gaijin, could be very popular in Japan)

“Are you going to die without seeing this exciting world out there?” (aimed at young people considering sacrificing themselves on the altar of Japanese big business)

“The age of depending on a salary is over – doing nothing itself is a risk!” (sounds a bit like George Soros, but is about setting up a micro-business)

One interesting thing was that although it is possible to find books written by Japanese authors (and Japanese author books are those shown prominently at the front of the shop), a very large proportion of this job is books translated from English.

I tried to look for whether there was a tendency for negativity versus positivity in the Japanese titles, and it seems that negativity is much more popular, although perhaps that is a necessity if you are telling people how to break out of a crap job.

Lastly, I went to the front of the shop and asked the woman and man standing there whether they have noticed any trends in these kinds of books.

The woman said that the reason for the promise display is “Go gatsu-byo” (May disease), whereby people get a new job on schedule like the blossoming trees in April, spend a month working hard and not asking questions, but then Golden Week comes around in early May, and the new recruits have time to reflect on what they are doing and why. And many people in fact take a few sickies in May, hence “May disease”.

The man mumbled that he did not know about books, but that certainly he had seen a significant increase in TV programs on the subject lately. He looked like a TV watcher.

I must have surprised them for firstly being highly non-Japanese in appearance and secondly for interrogating them on a matter other than the location of the manga shelf, and they quickly adopted the relaxed posture of a corpse in winter.

I cannot conclude anything yet on this subject, but it is my contention that there are the stirrings of a trend in this area.

Underreported news May 19, 2013

Only two items of what I feel is underreported news in the Nikkei this weekend:

1. Abe’s deregulation plans only concern big business. Medium and small business owners are already unhappy about it.

He plans to, for instance, make it easy for Toyota to make driverless cars or some computer company to mess around with “big data”.

In my view, on the issue of availability of personal data, for all the hot air blown by committee men in cushy government jobs, and no matter how apparently strict the laws on the issue, the reality is that the government is already making plans to rob citizens of their privacy by in effect giving away their medical data to companies. I cannot tell you where I got the information that forms the basis for this view, but it was not from the paper.

But for the majority of people in Japan, this means that there will be no fundamental change or reform, other than darker shades of kleptocracy.

Of course we shouldn’t blame Abe, whose name taken literally incidentally means “Safety Multiplier”. For the man is just a politician, and the whole system has to move along a path of minimized resistance.

And yet the very foundation stone of the government’s policy is an increase in private investment, for without that there will be no transmission between increased Ferrari sales now and a multiplier effect in one or two years’ time. But the lack of deregulation means there is no point of increasing investment in Japan at all.

2. Fish prices

Katsuo-bushi (fluffy fish flakes that form the basis of the stock that goes into most Japanese food) are going up in price. Volumes are down and demand is up, especially from SE Asia and China. Japanese processors are getting squeezed as the supermarkets are giving them hell to keep a lid on prices, premiums for Japanese-grade quality over Bangkok spot prices have collapsed (making it difficult to get the premium quality needed for the Japanese market), serving sizes have already been reduced, inventories in Japan are at emergency low levels, and of course processor margins are very bad, meaning that the damn is near breaking point. The only thing holding it back is “consumer expectations”. It will be interesting to watch those expectations be reshaped.

1. The question is basically how come Japanese companies with loads of cash have some borrowings? Is it a favor to their banks?

A: If you look at Western companies with loads of cash then they will sometimes have a little bit of borrowings too. The reason is that a company will have many subsidiaries and they might have a preference for holding cash at the parent level or in one subsidiary while not caring very much about small short-term debt which the bank will charge them very little for anyway. I agree that when you consolidate you see a picture that looks odd – you would imagine that you could just net it out and save a bit on borrowing. There may also be a bit of doing favors for their mates at banks who they play golf with, but I am not worried about this.

2. What will companies do with all their excess cash balances?

A: The government wants them to invest it, shareholders want them to pay it out, but the management wants to sit on it as a large tub of soothing balm for their mental scars from the 1990s, and/ or spend (i.e. waste) it on acquisitions, with South East Asia being the default choice now that China is not buying Japanese stuff. Things change slowly in Japan, and shareholder-friendly moves will occur at a glacial speed.

3. Property values – whether to incorporate them and how to do it

A: Yes – incorporate them. If your process starts with a defensive analysis (e.g. break-up value), as does mine, then you can throw in the property value as part of the baseline worth of the company. However, remember that in reality if you sell a building in a going concern, you release capital but create an ongoing lease liability, so if you are modeling the P&L to any degree of precision, you will need a handle on that. I don’t need precision, but I will chuck in a discount to the potential FCF in my rough-and-ready approach. I assign zero value for crap buildings (e.g. warehouses), or just give them a discounted land-only value, and discount premium property less. I am not fully on top of the move to IFRS, but it may actually result in worse disclosure in things like land and buildings.

How to do it: there is no Zillow in Japan that I am aware of, but this is probably the easiest thing for you to use:

http://www.land.mlit.go.jp/webland_english/servlet/MainServlet

Also, as a general thing, remember that a property in Japan will need to be destroyed and rebuilt after perhaps 50 years due to earthquakes. For your interest, if you are a resident (not necessarily a national) – like me – then you can buy distressed properties at auction: http://bit.sikkou.jp/

4. “Treasury shares not yet retired – I subtract these from shares issued”

I agree. Unless you have reason to believe management will sell them or give them out for “performance”.

5. Psychological change due to Abenomics?

Depends who you speak to. Ferrari dealers = V. happy

Nomura sales people = V. happy

Workers at Toyota = Happy

Ordinary salarymen = Don’t care/ Not happy

Processors of raw materials = V. unhappy

Consider that the media has been going full blast warning over inflation and speculating over Abenomics, and actual inflation is starting (e.g. taxi fares just went up in Tokyo), but the fear of it is definitely not apparent.

We have an entire lost generation with all their hopes, dreams, etc. based on experience of falling prices, a weak economy, and people becoming increasingly zombified. Six months is just not long enough.

For most people, even if they could break out of their zombie mind-frame, what exactly would they do anyway?

I will answer questions about analogies with China elsewhere.

6. Olympics in Japan? The only sport I know is tennis. And technically I should add swimming, as I have just come back from a swim, but it is hardly a good spectator sport. I am probably the least qualified literate person to comment on this – I just have no idea. Wake me up when Usain is on.

The horse has been incorrectly positioned, in relative terms, and it all boils down to the current account and capital account, which is why the music needs to keep on playing.

Let me explain.

I’m not entirely sure how well the Japanese government has thought all of this through, but their policy of cheapening the yen is causing the trade gap to close quite quickly.

And this is an early sign indicating a reversal of the trade balance deterioration during the strong yen period. You cannot see the effect on this long term chart, but a narrowing trade deficit means that the tendency is for the decline here to slow (and ultimately reverse).

The yen has been declining dramatically, and this trade data is over a month old, so presumably the present level of the yen may narrow or even close the negative trade position.

Note that Japan’s current account is already in surplus, as non-tradable flows such as license fees and dividends are a major part.

I believe that this reversal is setting the scene to cause a turnaround in the capital flows that have been associated with the yen decline. This would be significant and, apparently, surprising.

Here is what has been happening to capital flows (units: 100 M Yen). These charts show the flows in/out of Japan for equities, bonds, and money market instruments combined:

Source: http://www.mof.go.jp

Positive numbers are inflows to Japan.

Foreigners have been buying equities, as you can see if you break out the foreigner share purchases.

Japanese institutions have been net sellers to foreigners.

In fact, the selling by Japanese institutions is very high.

So we have an interesting situation whereby foreigners have come in and front-run something (anticipated major capital flows out of Japan) that has not yet happened, in complete disagreement to domestic institutions.

And, if the current account stays positive due to the weak yen, what do you think will happen?

Firstly, putting circular/feedback effects to one side, positive current account inflows ought to cause capital to leave the country, just like for most of Japan’s history. Most of the time, Japan has been a surplus earner and an exporter of capital. This means that its business model has been to import timber, rubber, rocks, oil etc., make it into Sony and Toyota products, sell the profits to depreciate the yen, and use (“export”) the acquired dollars to buy US government debt. The difference nowadays is that those financial flows (not tradable products) are big and constantly streaming into Japan. (Remember that the current account and capital account have to balance.)

If you did not understand that, what I am saying is: it is not different this time, and Japan will go back to its old ways if you give it a cheap currency with no structural reform.

The government wants to stop deflation by weakening the yen and causing an inflation mindset. But there is a real risk that they will screw it up due to causing a trade surplus.

It seems to me that the horse has been allocated somewhat toward the rear end of the carriage.

You see, in the US, UK, and other debtor nations, the debt is fine as long as kindly obliging countries like Korea, Japan, and China are willing to lend you the money and cheapen their own currencies for the privilege of continuing to do so. But Japan cannot borrow money from other countries in any serious amount. Firstly, the interest rates would be so high that the banks would all collapse (or hobble along under fake accounting, pretending that they are fine but being super-zombies), and secondly, Japan’s unwritten rule, since like forever, has been that she shall not be dependent on foreigners for funding (nor for much else other than minerals and cheese), unless said foreigners demolish all her productive capacity with bomber aircraft.

This is a bit of an issue for best-laid plans, as the lack of overseas debt financing as an option means that current account surpluses will be maintained again, and this may undermine the whole Abe program.

The causes of deflation are argued over, but it is broadly accepted that deflation is linked to a high yen, and a high yen is worse during “risk off” periods in the global markets. This is because, during such periods, Japanese investors do not want to invest overseas, leaving incoming capital piling up inside the country and causing demand for yen to be relatively high (as money in other currencies still needs to be converted to yen due to financial flows, while there is less yen being sent outside the country for investment), and thereby deflation.

When we have a deficit in the current account (mainly due to selling less Toyotas), then it is somewhat easy to cause the currency to fall. But when we don’t, then it isn’t.

Therefore, now that the country’s current account surplus has gone up again, the yen will be at the mercy of capital flows, which means the next time the highly frothy equity markets go down, the yen is likely to go up a lot. Add to that the fact that there is a lot of yen shorting by speculators and you have the potential for a nasty sharp unwind unless the music, which sounds like that of a horror movie to me, keeps playing. As an indicator, the short yen position on the Comex amongst small speculators is the largest ever (I think), and amongst large ones it is the highest since around 2007, when the carry trade was popular.

Let me be clear – this is not to say that a current account surplus equals a strong yen, just that it narrows the possibilities. It means that there need to be capital outflows for the yen to not strengthen.

The risks to my view are as follows:

Risk 1. Japanese investors may start sending capital overseas. Ok – where? Bonds are expensive everywhere, stocks overall are a joke*, and everything has been made more expensive when viewed from this side due to the depreciation – are you surprised that capital has been staying at home? But it is still a risk, as it is difficult to say how investors will react if the yen keeps on falling. If it does, and if they do decide to stampede out, then the yen may well crash, but eventually the current account surplus will bring it back.

*On the subject of Japanese equities themselves, I cannot look at any more crap about “still attractive” for 15-20x earnings and 2x BV for companies with Japanese “governance” and competitive positions dependent on the weak yen … makes me sick

Risk 2. Global interest rates rise due to a strong economy. But as I have argued before: A ha ha ha ha ha! A ha ha ha ha ha! A ha ha ha ha ha!

Now, why is this cart behind the horse?

Simply because the government wants to cure deflation by getting the yen to fall, but in the long-term the currency is a symptom, not an underlying cause. They want to get the yen down, increase wealth, and cause increased spending. But it should be the other way around, namely:

Improve economy structurally => More productivity => More income => More spending => Less deflation

This is the backwards way they have it:

Devalue yen => Change inflation expectations => More spending => Less deflation => More prosperity => Structural economic improvements

If every country could get rich by devaluation…

I may be wrong as to their thinking, because government bamboozles me, and I have left out the fiscal part because we are mainly here talking about the yen, but on that I will just say that Japan does not lack for investment capital, just productive investment opportunities given the communist nature of everything in the economy.

As I have argued before, the yen can fall, but increased surpluses will be a brake on inflation (and on the yen falling). Not only that, but it seems that the “Change expectations” part is only working by squeezing household budgets, not in a positive way (unless you work for Nomura/ a Ferrari showroom).

Back to the near term, I am not going to say that the yen will now turn around on a sixpence, but I will say that the setup is ready for a big increase in the price of the yen vs. the dollar as soon as the capital flows move in the way that they usually do in an equity downdraft. Except this time I expect the move could mainly consist of foreigners bailing out of their speculative positions.

Is that enlightening? Probably not much. All this says is “watch out”. And for the record, I am taking the side of the domestic institutions in the argument while also keeping quite a high exposure to conservatively-valued Japanese stocks.

Intangibly whatever?

I have forgotten which, but a famous book on investing (probably Quality of Earnings) features a story in which the author found a company selling below book value, only to discover that it mostly consisted of a lame radio jingle, which went something like “X is the beer to have when you’re having more than one”.

I probably do not need to remind you that I look at intangible assets with a certain disdain. I am a cheapo investor, hoping that this gives me a little bit of room to be wrong and still end up right. My basic starting point in most things, both within and outside investing, is “you want me to pay WHAT?”

However, having said that, some of my best investments to date have been companies with cheap valuations and essentially zero value pencilled in for intangible assets, despite the quite obvious value of such intangibles. The one that comes most readily to mind is Stanley Gibbons, which is still a major part of my non-Japanese portfolio.

In Japan there are quite a few similar cases of underappreciated intangibles, but it is obviously difficult for non-Japanese investors to understand this kind of value. To be honest, it is even difficult for me in many situations when I have not been to a given prefecture where a company has its stores, for instance.

The following company is an average sports product brand which is not exceptionally stretched on valuation and does arguably offer reasonable safety.

(MM Yen)

They have had depreciation running well ahead of capex recently, so you can perhaps add another billion on to get to FCF.

NB: The above op inc numbers do not include 2008, which was much higher.

The company has been growing overseas, doing a particularly good job in the US and Asia/Australia. They say that Asia will now shrink as the Chinese boycott Japanese goods. Interestingly, there was an article in the Nikkei a few weeks ago saying that Japanese brands are doing surprisingly well in China due to their reputation for quality, but the main beneficiaries are folks like food companies and air purifier manufacturers.

This company spent a load of money on the Olympics, and I do not expect there to be any particular catalyst to launch it into mega-profits. Probably the market is also not expecting much of them either, as the share price has gone nowhere for a while. But they are slowly expanding, particularly in US/European shoes.

Mkt cap = 51.8 B Yen

Lease obligations are minor.

I cut the buildings and land by 25% because it is difficult to evaluate their real estate. This is due to a. their lumping together some retail and general business assets by geographical area, and b. because the largest asset in there is their HQ building. Although the location is very good – not far from where I used to live – it is risky to assign a large value to a single asset like this.  Especially if you are as timid as a squirrel, as I am.

(http://ja.wikipedia.org/wiki/%E3%83%9F%E3%82%BA%E3%83%8E).

The big red rectangle is Osaka station, the pointer (C) is Mizuno’s HQ building. Funny how all the foreign analysts are drooling over REITs but no one seems to be yet examining real estate on ordinary company balance sheets …anyway…

They have over 18,000 m2 in mainly second-tier (and some prime retail) Osaka land & buildings, 1,800 m2 in Tokyo, and some elsewhere.

LT investments are mainly shares (c. 80%) and bonds. I left them valued as-is, even though they will be more expensively marked now – same applies for marketable securities in the current assets. “Other” investment assets appear to be some niche trusts set up by the likes of Nomura et al. – no idea what they might really be worth, but probably they are worth something, so a 75% cut should cover it.

That gives us an enterprise value adjusted using my method of around 16B Yen.

The question now becomes, what are we willing to pay for a so-so sports goods company with a bankruptcy value of something like 36B Yen?

If the free cash flow were to stay at something like 3B Yen, then would the current market cap of around 51B Yen make sense? No, I think it would be too low. The reason is because this is a company that will probably grow over time, it has recently been spending a lot of money on advertising (particularly at the 2012 Olympics) and therefore near-term earnings will be depressed, and you should get something for its stability – or, if you prefer, for its brand name or share-of-mind or whatever. The name of the company is Mizuno. I think that to set up this company would probably cost more than 51 – 36 = c. 15 B Yen. Just as a fun fact, Nike spent $2.711 B in FY2012 on what it calls “Demand creation” – basically promotion. ASICS spent 20.755 B Yen.

I do not think that Mizuno is going to suddenly skyrocket here or anything. I just have a sense that it has to be worth, on a net basis, more than what ASICS spends on advertising in one year, and it is fairly safe due to its core business in Japan and its balance sheet. For those not looking at niche micro-caps this is one to consider – they even have English data, it seems. I hold some shares in this company, and would like the market to give me a bit of a discount for me to increase my conviction on this name. Without any fundamental change to the currently-visible earnings picture, I would venture that the business could change hands between reasonable people for something like the 36 B Yen of bankruptcy value plus 10 x 3 B Yen of realistically achievable long-term sustainable FCF (reasonable people can disagree here), and then at least 10 B Yen for the intangible value – pocket change for a name that has been around since 1906. That comes to 75.5 B Yen, which translates into a share price of 46% above where we are now, and just a bit below my target rate of return. Of course, if I am correct that the market is ignoring the potential for any kind of improvement in the near term and if any improvement materializes, then the market is likely to go nuts and assign all kinds of hopes, dreams, and bold predictions and way overshoot a conservative valuation – but I am not counting on that. In fact, the company is a little bit mangy and I would not be surprised if they screwed something up in the short term.

By the way – my sports shoes are ASICS.