Industry Updates

Worried investors should buy 'undervalued' Japan says Corrigan

Scott Longley

Japanese corporates are defying the macroeconomic mantra that you cannot have economic progress without inflation by achieving average annual rises in pre-tax profits of 4.3 percent, says Sean Corrigan, financial markets consultant with Cantillon Consulting.

In his debut column for ETFstream, Corrigan says that despite Japanese corporate revenues having been "stagnant" for the past 25 years, they have managed to grow pre-tax profits over the same period at a trend rate of circa 4.3%.

He adds that such data "not only gives the lie to the mindlessly-repeated idea that price inflation is a prerequisite of economic advance, but also shows that a determined entrepreneurial effort can indeed squeeze more blood out of a seemingly unyielding stone."

He goes on to say that pre-tax margins in Japan are actually at their best level "in more than half a century of data" with the stereotypically lagging non-manufacturers having improved even more than their industrial counterparts in the past few years.

Corrigan points out that corporate balance sheets are "generally more sound" than they have been in the past with net debt for Japanese corporates at around three times operating income compared to somewhere closer to five times for US corporates.

"With labour markets eye-wateringly tight, signs are emerging that some of that vast pile of cash is being more liberally invested in aids to productivity - things such as automation, robotics, and smart systems," he says.

"Not only is a successful implementation of this likely to increase margins further in the coming years but, as a macro-economic identity, fully-reckoned revenues will only be partially offset by contemporaneous costs above the line, thus boosting overall accounting profits long before a switch has been thrown on the newly-improved assembly-line."

The backdrop is further improved by the current selling of Japanese government debt by institutional investors to the Bank of Japan. That money is being recycled into equities. Meanwhile, the push on the part of the authorities to modernise Japan's corporate governance efforts means that shareholders are at long last being given due priority when it comes to company strategy.

Finally, Corrigan adds that the Japanese stock markets - despite having posted double-digit gains in the past year - are still languishing at modern-era lows when measured against the pricier markets in Europe and particularly the US.

Indeed, Corrigan suggests that the evident asset price inflation in bonds, equities as well as alternative investments such as wine and art means that investors should not become enamoured with the accumulated cash earned in recent years and believe they are capable of always producing superior investors.

"By all means, run your profits, if you are one of lucky souls to have been at the table these past few years, but do think to take some protection on the downside (with market volatility at record lows, this is cheap enough to buy) and, above all, do not be tempted to add further to your exposures," he says.

Conversely, he adds that if investors have not yet been convinced of the sustainability of the rally then now is "decidedly not the moment" to overturn any long-held scepticism.

"History shows that the single greatest determinant of future returns is the initial price you pay to secure them," he points out. "A market characterised by elevated multiples (in other words, by abnormally low yields) is therefore not the most propitious of outlets for your belated enthusiasm, especially since such multiples tend to exhibit a good deal of long-term reversion to the mean."


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