Reporting by Greg Debski, CFA & Kent Cheesborough, Analyst
There is an adage in the finance industry: “when the Fed sneezes, the whole world catches a cold.” In less than a years’ time, the Fed (the US Federal Reserve) increased interest rates from 0.25% to 4.25%—the fastest pace of interest rate increases ever! So after a year of the Fed sneezing heavily, we approached the end of 2022 on the lookout for who was feeling under the weather. One country which certainly caught a cold: Japan. After about five years of relative stability, the Japanese Yen fell precipitously against the US Dollar during 2022, at one point reaching a 24% decline for the year. That significant currency discount hinted to us, as USD-based value investors, that opportunities could be waiting. Our interest was piqued, so we packed our bags and set off to check the patient’s temperature.
Often the most valuable information obtainable on a culture, economy, or business is simply not available on Bloomberg screens, financial disclosures, or conference call transcripts. So, we venture around the planet on a somewhat regular basis to uncover what is meant between the lines of what is being said. We headed to Japan with typical preconceived notions: efficient companies, widespread ingenuity, hardworking people, and a stable capitalistic society. While largely true, many of those notions come with nasty caveats, large implications, and minimal lip service.
The past several decades of economic history have also had significant impact on the current landscape in Japan. Beginning in the mid-1980s, Japan experienced a truly astounding equity market bubble. At one point Japan was even said to be taking over the world, with a global shopping spree including Rockefeller Center and even the Pebble Beach Golf Resort. The Nikkei 225, the key equity benchmark for Japanese companies, rose from a level of about 8,000 in 1983 to nearly 39,000 in 1989, a stunning 387% increase. Over the next 13 years, the Nikkei 225 proceeded to decline by 80% in one of the most brutal long-term bear markets in modern history. To this day, the highs set in 1989 have not been surpassed. Combine that with another 50% market crash in 2008, sprinkle in a few currency crises (plural…), and it becomes understandable why the investment temperament of both Japanese individuals and businesses is “risk-averse.” Japan has the oldest population by median age in the world3 and with that comes long memories of difficult investment experiences for the last three decades. No wonder only 15% of individuals in the country dare to own stocks, or even bonds. Of the 2.7 quadrillion Yen4 (about 15 trillion USD) of total household wealth in Japan, over 40% is held in either bank deposits or physical cash!5
Our research trip came and went with a flurry of additional meetings and interviews. The types of companies we visited covered a broad spectrum of the global business environment: a commercial real estate manager, a commodity mining and production conglomerate, a manufacturer of train parts and construction equipment, and everything in between. While our initial currency-related investment premise evaporated rather quickly, a new idea began to shine through—like the warm light of a rising sun. The biggest sources of risk in Japan seem to be the aging population and the financial engineering being conducted by the central bank. We need to pay close attention to investment opportunities where those risks are minimized. Japanese ingenuity is alive and well, with hardworking and disciplined individuals laboring tirelessly in the background to create products the world needs. Our objective is to find those businesses which leverage that ingenuity, talent, and commitment without getting wrapped up in the societal dramas or financialization games.