Japan’s stock market pulled back from a five-week high Monday following news of weaker-than-expected economic growth and higher-than-expected trade deficit. While Japan’s economy struggles to achieve escape velocity, Japanese blue chips may present a bargain buying opportunity given that the shares are undervalued compared the U.S. and other developed foreign markets.
The island nation’s economy grew at an annual rate of 0.7 percent, missing expectations of one percent growth. The current-account deficit, the difference between the country’s imports and exports, expanded to $15.4 billion, the largest since 1985. Stocks trading in Tokyo fell about one percent. At the same time, investors are waiting to hear from the Japan’s central bank governor Tuesday following a two-day policy meeting. The Bank of Japan is expected to leave monetary policy the same.
Japan’s unprecedented currency debasement and economic reform plans enacted last year to in hopes of boosting inflation, consumer spending and corporate profits has succeeded in lifting corporate profits but not workers’ wages. Prime Minister Shinzo Abe is pressuring large manufacturers, which benefited from a weak yen, to pass along the wealth by increasing salaries. But the trickle down effect is failing to reach consumers because most people don’t work for large corporations, says economist Harry Dent, founder of Dent Research in Delray Beach, Fla.
“This is a pressing issue because (consumer) prices have increased 1.5 percent in the past year,” Dent wrote in a client missive Friday. “Without more income, consumers are going backward.”
“Look for a lot of self-congratulatory speech making from the Japanese about their progress, even though very little will be changing for most of the population,” Dent added.
iShares MSCI Japan ETF (ticker: EWJ) is the most widely-traded fund tracking the island nation with $14.1 billion in assets under management. It has tumbled four percent year to date while gaining 13 percent in the past year, underperforming foreign developed markets over both time periods, according to Morningstar data. iShares MSCI EAFE Index ETF (EFA), the benchmark for developed foreign markets, added one percent year to date and 17 percent over the past year. WisdomTree Japan Hedged Equity ETF (DXJ), which hedges its exposure to the yen, lost five percent year to date while rising 17 percent in the past year.
Japan’s stock market may be floundering on doubts of Abe’s ability to turnaround the economy, which peaked in the early 90s, but Japan ETFs may present a bargain buying opportunity. They may have been unduly punished because they are based in Japan, but they derive most of their earnings overseas. Most holdings in iShares MSCI Japan and WisdomTree Japan Hedged Equity are global brands such as Toyota Motor Corporation, Mitsubishi Financial, Honda Motor, Hitachi and Panasonic.
Stocks in iShares MSCI Japan trade at 13.7 times forward earnings and 1.1 times book value. WisdomTree Japan Hedged Equity has a P/E ratio of 13 and a similar P/B ratio. Both ETFs are undervalued compared with iShares MSCI EAFE, which trades at 14.6 times forward earnings and 1.5 times book value. SPDR S&P 500 ETF (SPY), the most widely used measure for the U.S. stock market, sports a P/E ratio of 16 and P/B ratio of 2.25.
The world’s largest automaker, Toyota (TM) is the largest holding in iShares MSCI Japan, accounting for nearly six percent of the fund’s assets. Toyota’s stock price has skidded eight percent year to date. Thanks to a weak yen, the automaker blasted profits fivefold to $5.1 billion in its fiscal third quarter while revenues revved up 24 percent to $6.5 trillion.
“The disparity between revenue growth and income growth highlights just how much the automaker is gaining from Prime Minister Shinzo Abe’s policy of yen devaluation,” an equity analyst withTrefis.com wrote in client note March 6. “Toyota has benefited hugely from a deteriorating yen since the automaker produces almost 40 percent of its vehicles in Japan.”
The yen has appreciated about 2 percent against the US dollar year to date but has depreciated about 7 percent against the greenback on a 12-month basis.Profits earned overseas convert back to more yen the weaker the yen. Trefis has a price target for Toyota shares of $123, about 10 percent higher than its current price near $114. Toyota shares are undervalued relative to its industry. It trades at 10 times forward earnings and 1.3 times book value while the industry’s average P/E is 11.5 and P/B is 1.6.
Toyota expects to increase sales this year by 12 percent to $18.5 billion. Emerging markets account for about 45 percent of total sales while North America makes up about a third. Japan makes up only about a quarter of Toyota’s unit sales. Japanese customers are rushing to buy new cars before April of this year,when sales taxes are new vehicles will increase. But they higher sales tax could depress demand thereafter.
Japan’s stock market may be a bargain buying opportunity because of its low valuations, but there is always a risk of cheap shares getting cheaper.
By Quynh Ho