Where we in this market right now?

by admin on April 24, 2013

Where we in this market right now?

To say that the last year has been difficult to anticipate would be a ridiculously British understatement.

So much so, in fact, that I have taken the unusual expedient of getting some history books – I am reading this one in particular:

Finance book 1

And this one is for later:

Finance book 2

I’m currently reading about the end of the 1970s. What a different world it was then! The 1974 bear market, for instance, was so bad that the FTSE 30 index hit a PE of 3.8 at the end of that year, at which time it was yielding 13.4% (government securities were giving you about 16%).

Every constituent of the FTSE 30 could have been bought out for six months of Saudi Arabia’s oil revenues at the time.

NB: I encourage anybody who thinks they can read chart patterns to take a stock chart leading up to 1971, 1972, or 1973, and report back to me their basis for any sort of prediction of the future. The truth is that there is a grain of usefulness in charts, but it is not in treating them as sources of profound knowledge. A chart can tell you that there is excessive selling, for instance, but if you do not know what something is worth in the first place then you will have trouble putting that information to use.

Socialism was alive and well, labour unions were more strongly represented in politics than was business, there were price controls, huge taxes relative to nowadays, mindbending price and wage increases, civil unrest, and there were genuine plans in government for direct control of major British enterprises.

So, you see, the reason why it’s so difficult to understand the world at that time is because the very starting point of any discussion about business was about excess demand and difficulties in getting supply – the very opposite, as you know, of the situation we find ourselves in today. Of course, that doesn’t mean that we can’t learn from the past, but one of the most important lessons must be that we have to take extreme care in making comparisons with only a generation ago.

The book itself is not terribly engagingly written. For instance, if you don’t know the names of British prime ministers, you would need to have Wikipedia at hand to help you through. Although that is not a problem for me, I think that it attempts to factor in too much detail, spreading itself too thinly in many places.

A typical randomly-selected comment (from 1971):

“ September saw a 1% cut in Bank Rate to 5%, partly in a defensive move to stem the persistent inflow of hot money as the pound rose towards $2.50 but also in response to the chorus of calls for more reflation as the numbers of unemployed continued to climb. … The move pulled the FT 30 back to the 400 level again, but by the end of November both markets [UK & US] were rallying sharply on signs of progress in the latest round of monetary talks.”

=> Is it just me who sees this as too shallow to satisfy? Is it enough to list every rally and drop and attach a headline-grab for it? Would it not be better to leave out some of the minor moves and paint a picture of the factors crystallising the psychology amongst participants of the day?

The best part so far has been reading about the delay between the first oil shock and the market reaction weeks later (although no in depth exploration as to why this was the case).

Nonetheless, given that there is little of this kind of material out there, I think it is still worth reading, as long as you view it as a starting point, from which you can build up your own analysis.


Now, back to the present day:

The Japanese market situation is unquestionably one for the history books.

Here are my issues with the market at present:

1. The market as a whole is way too expensive. Although I am not an expert on big dumb companies, members in this category of speculative interest have priced in large increases in wonderfulness and nothing less than an abundance of fortune. Arguably much greater marvels of prosperity are being factored in than can reasonably be forecast to any degree of error by anyone.

For instance, Toyota – a cyclical enterprise – is over 10x its peak earnings (of 2008), is full of debt, and faces big long-term issues (such as the Chinese wanting to make their own cars), and big short-term external issues (such as economic deterioration after several years of weak expansion), let alone its company-specific problems.

Hitachi – hardly a bellwether of stability – is 20x next year’s earnings (which are forecast to be lower than this year’s with no imminent recovery anticipated). Its share price is now at levels seen in 2007.

The last time Honda shares were priced at this level was a few months away from the peak of the last bull market. And it is not yet expected to exceed earnings of that year.

Mitsubishi UFJ shares have almost doubled in two quarters. Earnings are generally expected to fall next year. Admittedly, they are only at about book value, but what would happen to that book value if the bond market crashed? I do not think that the bond market will crash. But it might. And even if it does not, then what will happen to the value of those bonds and loans during inflation?

Amongst large but non-dumb companies, such as Unicharm or Sanrio, we are talking 35 and 28 times next years’ earnings. If you are playing that kind of game then you need to be following the quarters pretty closely.

As demonstrated from this randomly-picked list, the room for pencilling in margins of safety when investing in large stocks has collapsed. And when you look at small caps, the room is shrinking.

2. Having said that, I am scared to death of the yen falling. This means that my allocation to stocks is still uncomfortably high. As I said last month, I expect this quarter’s performance to be poor. I cannot tell you all my secrets, but I am allocating money to off-the-radar stocks, two of which are internationally known but not well appreciated. I will talk about them later.

The one I can toss out there now is a little-known net-net which I have a small position in: ヨンキュウ(9955). Basically, I think it will offer some protection of principal due to its balance sheet, and it also is exposed to inflation in a good way (it farms fish food). I knew about the stock a while ago, but I started looking at is again when I saw a story in the Nikkei Shimbun a few weeks ago talking about soaring costs of fish food.

Essentially, by allocating funds to stocks where I think that there has been little hot money affecting the price and the long-term risk reward remains favourable, I believe I am doing a good thing.

I still keep some yen, but this has been going down as I increased my allocation to gold following the sell-off last week.

I put in bids way, way underneath the bid price of the stocks I am buying, hoping that some poor weak-handed fellow will get scared into selling their holdings to me at a discount. If all these bids got hit then I would have to sell something – probably gold. These kinds of bids get hit sometimes. When they do I feel good.

3. I accept that we will get some turbulence. My main means of self-preservation here consist of taking a metaphorical chill pill.

You must accept that we will have corrections in this bull market. There is no way to tell when they will happen. But it is self-evident that a rapid rise in prices with increasing volatility will encounter some kind of correction before continuing, given that it is predicated on a. hot money inflows from foreign speculators (not me, though – I was already here), and b. devaluation which is being increasingly resisted by the likes of China and Korea, and soon other countries too, I guess.  Add to that the overstreatched US “safety play” stock market and you have a set up for some kind of blow up – an excess in excitement and then wild fearfulness upon trying to unwind herd-like trades is on the cards. The whole Japanese rally so far has only been two quarters old, and there is some evidence of a reach for yield occurring in Japan too.

You must accept that you do not need to chase (although I made my best money last quarter by breaking this rule – in fact, I pretty much break all my rules, then regret, then reafirm, cycle completes).

The greatest asset you all I have, I believe, is the ability to say “No”.

Let the market woo you with good values. If you did this you would be ok with the inevitable drawdown in the crazy 1970’s market.

If you do not fully understand why you are in a stock, be honest with yourself. Get out of it and stay with what you know. It is a marathon, not a sprint.

{ 4 comments… read them below or add one }

Frank April 28, 2013 at 8:51 pm

Nice post. I use IB but the only downside with that is IB doesn’t offer shares listed on the Osaka exchanges. I was wondering though, can I open a brokerage account in Japan as a foreign national (non-Japanese, non-resident)? Do I need a Japan domestic address? Just curious…



admin April 29, 2013 at 2:25 pm


Yes, you will need a Japanese bank account – and to get one of those you need a Japanese address. In theory, you could buy a property and get away with it, but they will definitely ask to see your visa.

If you are talking large numbers, such as over $10M or so, there are more options.




Frank April 28, 2013 at 8:57 pm

You are right, the jpy large caps are way too expensive to be called bargains but the small caps still offer reasonable valuation when compared to stocks in other global markets. However, the market has gone up too fast too soon and I am considering whether to put up equity hedges to give myself some protection when the eventual correction comes.

On a side note, I was wondering if you do hedge your JPY exposure? I do but only from the perspective of someone residing outside of Japan…


admin April 29, 2013 at 3:10 pm


There are stocks that are still cheap and are not the subject of mad speculation (yet). I expect them to be safer than the ones that have undergone rocket launches.

I do not hedge, except if you count buying gold with some of my cash – and I won’t go into that here because it is a long dinner-party type topic. I think that the yen may fall more, particularly if Soros’ scenario materialises. But that is not the only thing that might happen.

There may be hyperinflation, although if you look at how that occurs in history it does not just spring upon you like a thief in the night – it is a drawn-out process, starting with a pick-up in business activity. It is not consistent with what the Japanese economy looks like right now.

There may also be a return of the current account surplus (particularly if they switch the nuke plants back on as they are hinting in the media).

There may be another wave of deflation as everyone gets disappointed with the lack of efficacy of BoJ policies in the real economy.

There may be a crash in the stock market as foreigners decide to go someplace else.


But, basically, in order for Soros’ idea to play out you need both a continued current account deficit and a lack of investment flow demand for the yen.

Japan makes loads of stuff for export, and the imports that are making a difference on the margin are those of fuel. If the global economy does badly, then raw material imports will be cheap, exports will do badly, but there will be a rush of yen back into the country (as normally happens) – so therefore: bad economy = good yen. If the global economy does well, then exports will pick up, as will demand for the yen, although that will probably be outdone by investment flows – so therefore: good economy = mildly bad yen.

So it does not seem so simple after all. Longer term, of course, the yen is toast. In 20 or 30 years’ time the yen will be much lower against things like rice, vinegar, and fish because the output of the nation will be lower, saving negative, and the debt needs to be inflated away.

In the shorter term, one scenario in which the yen might collapse would be a huge rise in material prices and many current holders of yen assets deciding to buy things overseas. This could easily happen if there was a sharp rebound in the world economy (i.e. the opposite of what is happening right now).

Another is rising interest rates outside Japan, but who believes that?

My view is that before this kind of yen collapse happens it is rather more likely that foreign short-yen macro tourists get bored and the yen goes up and everyone starts talking about the end of Abenomics. I could be wrong. My allocation is not a reflection of that or the other scenario, but a weighted average thereof. Schizo, perhaps.

Also, I pay for stuff in yen, which means I have a different point of view.




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