Savvy Investors Look to That Other Asian Giant

This article is from the archive of The New York Sun before the launch of its new website in 2022. The Sun has neither altered nor updated such articles but will seek to correct any errors, mis-categorizations or other problems introduced during transfer.

The New York Sun

China may not be the big story anymore. A turnaround taking place in Japan may be much more significant to the global economy.


Why? Because Japan is much larger than China; Japan’s GDP last year totaled $4.6 trillion, while China weighed in at only $1.654 trillion. China has to grow at nearly 6% to produce the same incremental demand that Japan generates through 2% growth.


While most of the world has been transfixed by China over the past two years, Chuck Clough has been quietly building his portfolio in Japan. Mr. Clough, a former investment strategist for Merrill Lynch and currently manager of Clough Capital Partners, tends to play one or two principle investment themes at a time, making concentrated bets. In other words, he plays the big picture. And he is usually right.


Today Mr.Clough is bullish on Japan. He sees not only a powerful economic recovery beginning to take place but is also impressed by recent political developments. Japanese equities now represent his fund’s biggest bet.


He’s not alone. Sharon Dodgson, who runs Japanese funds out of London for Bessemer Trust, is “quite enthusiastic for the first time in 15 years.” A recent poll of money managers conducted by Merrill Lynch picked Japan as the top market for next year.


Talk about a turnaround. Not long ago, most people had written Japan off as a country heavily burdened with an aging population, high fixed costs, fragile banks, a rigid retail structure, and hopelessly tuned-out politicians. What’s changed?


The key to the rebounding Japanese market, according to Mr. Clough, is “the end of balance sheet liquidation” in that country. After many years of asset deflation (the unwinding of the 1980s bubble) he believes consumer spending is set to increase. The Japanese economy presents a mirror image of our own. Whereas American consumers have been encouraged by record inflation in home prices to take on unprecedented levels of debt, leaving them vulnerable, the Japanese household owes virtually nothing, but instead has accumulated cash resources.


Ms. Dodgson concurs. Her view is that the country is at an inflexion point, where deflation is giving way to inflation. The upshot is that people and companies are beginning to have renewed confidence in investing. Corporate profits are no longer being dragged down by asset write-downs, and consumers can return to buying hard assets.


Positive indicators include signs that housing prices in Japan have started to move higher and that the number of jobs is growing again. According to Ms. Dodgson, the hiring of college graduates in Japan is at the highest level recorded since the bubble burst in 1989. Also, in manufacturing areas, employment is actually tight. In one industrial area, for example, where Toyota is located, there are currently 1.7 jobs per applicant.


There is a generational shift taking place as well that could benefit the economy. As in America, baby boomers are beginning to retire, and the young people moving in behind them are, by comparison, big spenders. Ms. Dodgson cautions that this is a relative comment. The young people of Japan have been traumatized by the recession of the last 15 years and are moving toward home ownership, for instance, quite cautiously. Nonetheless, compared to their parents, they are likely to spend a higher level of their income on lifestyle improvements.


Mr. Clough points out that corporate profits bottomed out in 2002 and are rising nicely. Because of high liquidity levels and an upturn in final demand, a capital spending cycle seems imminent.


Moreover, Prime Minister Koizumi is actually overturning some of the country’s crippling regulations. The recent surprise election results validated the government’s cautious moves towards liberalizing the economy, and further consolidated Mr. Koizumi’s control of the Liberal Democratic Party. In response, the Diet party easily voted to privatize, albeit over an extended period, the Post Office.


This move is key. According to Mr. Clough, as much as one-third of Japanese savings is locked up in the Post Office, which functions as a huge state-owned savings bank. It holds more than $3 trillion in assets, thereby ranking as one of the largest financial institutions in the world. He sees privatization of this entity as likely to be extremely beneficial to financial institutions of all sorts. Brokerage firms and banks will be competing to invest monies coming out of the Post Office, revitalizing the financial sector. Indeed, one of his largest holdings at the moment is Bank of Yokohama.


Both Mr. Clough and Ms. Dodgson favor investments in domestic companies in Japan, since those are most likely to rally behind the upswing in economic activity. Like Mr. Clough, Ms. Dodgson likes the financial stocks, which she expects to benefit from an upturn in interest rates, and also favors real estate and hard asset companies.


Mr. Clough points out that there are various ETFs, which make investing in Japan fairly easy for individuals. One, the iShares MSCI Japan Index, which mimics the performance of the largest stocks in the Nikkei, is up this year 11.6% and has gained 26% over the past 12 months. Despite these gains, Mr. Clough points out that most Japanese stocks are selling at reasonable valuations of 10 to 14 times earnings; domestic companies are toward the low end of this range.


Though Mr. Clough thinks China is also clearly a formidable growth engine, he points out that it is difficult to invest in local companies, due to regulations and because shareholders have virtually no rights. Also, Japan has less political risk than China.


Lest you think you’ve missed the move, remember that the Nikkei sold at nearly 40,000 in December 1989. It closed yesterday at 13,190.There seems to be some room on the upside.



Mrs. Peek is an investor in Mr. Clough’s fund. E-mail her at peek10021@aol.com.


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