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June 24, 2008

Picture du Jour: Sun Rising Over Japanese Stocks
by Prieur du Plessis

Scanning the globe for investment destinations can be a daunting task. When it comes to stock markets, however, relative strength analysis serves a useful purpose of highlighting under- or outperforming markets (or individual stocks) at a glance. Having perused a bunch of these charts, the Japanese situation stands out as being of particular interest.

Firstly, let's look at the long-term chart of the Nikkei 225 Average. Japan's stock market had an extended multi-year rally that started in earnest in the 70s and accelerated sharply in the 80s. The Nikkei peaked on December 29, 1989 at 38,915. During the devastating deflationary period that ensued the average dropped by a massive 80.5% to 7,607 on April 28, 2003. The Nikkei staged a recovery from 2003 until 2007 when the sub-prime fallout came into play.

Source: I-Net Bridge

Putting the Nikkei 225's performance in perspective makes for interesting reading, as shown by its relative performance compared with the S&P 500 Index in the chart below. A falling line, which was the case until the end of 2001, depicts Japanese stocks underperforming American stocks. Over the period 2002 to 2008 the relative performance of the Nikkei 225 and S&P 500 mapped out a broad sideways pattern.

Source: I-Net Bridge

Zeroing in on the shorter term, the Nikkei 225 has underperformed the Dow Jones World Index since the beginning of 2006, underperforming a basket of developed stock markets by 43% until the middle of March this year. But the tables seem to have started turning over the past three months as indicated by the relative strength graph (bottom section) in the graph below.

Source: StockCharts.com

Being cognizant of the fact that we have seen a number of false starts on the relative chart over the past six years, which factors might result in Japanese stocks maintaining their outperformance? David Fuller (Fullermoney) argues that there are at least two:

1. Japan is the most efficient user of oil (although Germany is probably a close second).

2. Japan has the lowest inflation rate of any country, but it is likely to rise.

"These two factors could be significant at a time when everyone is understandably concerned about high oil prices and global inflationary problems. However, Japan has the world's highest savings rates, partly due to the long deflation, but the prospect of higher inflation should encourage consumer demand. Also, we often hear about Japan's demographic problems but at least that means fewer poor to feed," said Fuller.

Furthermore, one of the single most important drivers of Japanese equities over the past few years has been the currency as shown by the strong historical inverse relationship between the yen and the Nikkei 225 in the graph below.

Source: StockCharts.com

The global interest rate outlook is important in trying to assess the outlook for the yen, especially as Japan lays claim to the world's lowest interest rates. With the Federal Reserve on hold for the moment, and with the European Central Bank's Trichet becoming obsessively hawkish, the yen has been under pressure against both the US dollar and euro on the back of expectations of widening interest rate differentials. Also, it is highly unlikely that the Bank of Japan (BoJ) will move rates higher - even with a "hawk" such as Kazuhito Ikeo expected to join the BoJ's rate-setting board.

The weaker yen will help Japanese exporters, just as the weak US dollar has been a boon for their US counterparts.

Japanese stocks will probably not escape the leash effect of Wall Street's bearish sentiment, but should be in a position to better fend off downside risks. I concur with David Fuller who regards Japan as "the best industrialized stock market for today's economic climate". An equally apt quote comes from a song by In the Groove: "I know that we can make it in the land of the risin' sun!"

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Dr Prieur du Plessis
investmentpostcards.com

With 25 years' experience in investment research and portfolio management, Dr Prieur du Plessis is one of the most experienced and well-known investment professionals in South Africa. More than 1 000 of his articles on investment-related topics have been published in various regular newspaper, journal and Internet columns. He also published a book, Financial Basics: Investment, in 2002.

He holds the following degrees: BSc (Quantity Surveying) (Cape Town), HonsB (B & A) (cum laude) (Stellenbosch), MBA (cum laude) (Stellenbosch); and DBA (Doctor of Financial Management) (Stellenbosch).

Prieur is chairman of the Plexus group of companies, which he founded in 1995. Previously he was general manager: portfolio management at Sanlam, responsible for the management of investment portfolios with total assets in excess of $5 billion.

Plexus is a pioneer in the mutual fund industry and has achieved a number of firsts under Prieur's leadership. These include the authoritative Plexus Survey, a quarterly analysis of the consistency of the performance of unit trust management companies, the Plexus Offshore Survey, the Plexus Unit Trust Indices, and the PlexCrown Fund Ratings.

Plexus is the South African partner of John Mauldin, American author of the most widely distributed investment newsletter in the world, and also has an exclusive licensing agreement with California-based Research Affiliates for managing and distributing its enhanced Fundamental Index™ methodology in the Pan-African area.

In 2001 Prieur received the Santam/AHI Business Leader of the Year award for corporate leadership, business acumen and entrepreneurial flair. He was also profiled in the book South Africa's Leading Managers (2006). Plexus received the AHI/Old Mutual Enterprise of the Year award in 1997 and was also included in the book South Africa's Most Promising Companies (2005).

Prieur is 52 years old and lives with his wife, TV producer and presenter Isabel Verwey, and two children in Welgemoed, Cape Town. His recreational activities include long-distance running, motor cycling and reading. He belongs to the Cape Town Club, Johannesburg Country Club, Gordon's Bay Yacht Club and Swiss Social & Sports Club.

Copyright © 2008-2009 Dr Prieur du Plessis

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