Where investing in Japan is concerned, I’m often reminded of a quote from actor Bill Murray.
He said: “In Japan…nothing makes any sense. They’re very polite, but you feel like a joke is being played on you the entire time.”
It’s true that Japan has been a graveyard for many an investor over the years, with many false dawns and lost hope, lending itself to the moniker of the proverbial value trap.
However, at times of elevated global economic, political and monetary policy uncertainty, investing using valuations as a starting reference is as strong a guide to future returns as one may have. With that in mind, one cannot help but recognise the current valuation of the Japanese financial sector.
If we consider three of the largest banks in Japan – Sumitomo Mitsui, Mizuho Financial and Mitsubishi UFJ – the price/earnings ratios are no higher than 7.8x, and the price-to-book ratios no greater than 0.53x.
These valuations are largely lower than at any time through the 2008-09 financial crisis, which perhaps brings context to the stress, or perceived stress, in the sector. If we drill down on the numbers and consider the third quarter of 2008 as a period of extreme stress for the global financial sector, Sumitomo Mitsui was trading at 12.8x earnings and 1.55x book on September 30 that year. Today, it trades at 6.55x and 0.53x, respectively, as of April 20.
The MSCI Japan Financials Index has fallen 22 per cent over the past year, with much of that negative performance coming in January and February 2016 as the Bank of Japan introduced a negative interest rate policy.
This policy clearly puts downward pressure on bank profits, so it is reasonable to argue that the sector deserves the moribund rating currently attributed to it.
However, taking a step back, these valuations do appear to price in a rather apocalyptic scenario.
The three banks generate no more than 50 per cent of their gross profit from net interest income, with the balance from other sources. This banking model lends itself to a broader revenue base, not necessarily linked directly to the Tokyo Interbank Offered Rate (Tibor).
Japanese bank balance sheets are strong, perhaps more so today than they ever have been due to the conservative approach adopted after the Asian banking crisis. Bankruptcies are low and exposure to the resources sector is limited. Yields are healthy (and payout ratios modest) – Sumitomo is currently yielding 4.2 per cent, Mizuho 4.5 per cent and Mitsubishi 3.5 per cent. This is not only enticing for foreign investors, but increasingly so for domestic investors considering the Japanese 10-year government bond yield is minus 0.13 per cent.
Investing in Japan can at times make little “sense” considering the demographics, the debt burden and the strength of the currency. But perhaps, with a value-led approach, allocating to the region – and specifically to the financial sector – may be quite sensible. The yields on offer are noteworthy compensation for being too early, with valuations offering the potential for an upside over the longer term.
James Sullivan is investment director and senior fund manager at Coram Asset Management
