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It was the famous global value investor John Templeton who coined the phrase “bull markets are born in pessimism, grow in skepticism, mature in optimism, and die in euphoria. Keep this in mind because it forms the foundation to my view that the Japanese equity market is in the very early stages of a bull market.
In 1989 the Nikkei topped out at 38900. Japanese stocks were the most highly priced on the planet. This in essence reflected how euphoric investors were about their future prospects. I remembered being lectured at university about the Japanese “economic miracle” over and over again in the late 1980s.
There definitely was an economic miracle but the problem was this led to Euphoria! At the time it seemed that everyone on the planet owned Japanese shares or property. Valuations redefined “extreme”. In the late 1980s the Japanese stock market accounted for about 40% of the market cap of the world stock market and I think the valuation of property in the financial district in Tokyo was more than the whole of California!
Prices of stocks will only move higher if there is a constant stream of new buyers to push prices higher. With everyone in Japan quite literally up to their eyeballs in Japanese stocks the market literally ran out of buyers. Prices started to crash and selling beget selling. The Japanese economic miracle died on Euphoria.
It has taken some 20 years to deflate the huge bubble of optimism and complacency in the Japanese stock market. With valuations of Japanese equities down some 75% since 1989, now we find a situation where sentiment and valuations of Japanese stocks is diametrically opposed to that which existed in late 1990s. Ownership of shares by individual investors in Japan has never been this low, well not in the last 50 years at least. Foreign ownership of Japanese stocks is virtually non-existent, i.e. foreign fund managers have not been this “underweight” Japanese stocks since the late 1970s.
Perhaps it should come as no surprise that the valuation of the “average Japanese stock” is near the lowest it has been in literally decades (the median price/book ratio of stocks listed on the Tokyo stock exchange is approximately 0.70x, and if you take out the excess cash on the books of Japanese companies this ratio is around 0.65x). But valuations are only half the story, over the last 10 years Japanese companies have dramatically reduced their debt to equity levels making significantly less reliant on debt funding, which has materially reduced their financial risk.
In addition to the above what makes me confident that Japanese stocks have hit rock bottom? There are very few people talking a bullish story on Japanese equities, yet after a devastating earthquake and a very strong Yen the average Japanese stock (as measured by mid and small cap stock indices) is trading at levels they were just before the earthquake struck in March. If they have not gone down now after all the negative sentiment I think they have reached a cyclical low. Remember, bull markets are born in pessimism!
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