When the consensus view on a particular asset is negative, or at the very least, not particularly optimistic, this prevailing sentiment is reflected in the price and valuation of the asset in question.
Imagine, for example, that most property buyers in Country X think that residential property in the south of the capital city is a poor investment. Perhaps levels of crime are high, or the area has received little investment, making it unattractive as a location to live. This perception among buyers in the market would be reflected in the prices of the properties in this area. As an active investor looking to generate strong long-term returns in property in Country X, this could be an interesting place to search for opportunities.
Now, the prevailing opinion among buyers could be correct. Perhaps this part of town will remain an unappealing place to live for the foreseeable future, and an investment today is a bad idea.
What if, on the other hand, the market consensus is missing something, and as such, the prices of the properties in this location are too low. A good example here would be if the government is planning to build a new subway line through the area, offering better transport links to more prosperous areas in the city and wider country. This information may not yet be reflected in market sentiment or in the prices of assets, especially if buyers in the market have an emotional reaction to buying property in this area.
In this case, buying undervalued property and getting ahead of the change in market sentiment could offer significant upside in returns, potentially much better returns than buying property assets in more well-established areas of the city where prices already reflect the market perception of high quality.
As investors in equity markets, we apply the same way of thinking to searching for investment opportunities. If a particular asset class, sector of the economy, company, or even assets in a specific country, have seen prices beaten down by negative perceptions and market sentiment, we think it is worth looking for opportunities to invest.
This does not mean we automatically invest, many times sentiment is correct and the lower prices and valuations on offer are justified by the bad news and poor outlook for the assets in question. We would not be investing in Ukraine right now, for example, though there will probably be a day when that could be a good idea!
This brings us onto the topic for this week: Japan.
Japan had one of the strongest stock market booms in history in the 1980s. Expectations that Japan would potentially even surpass the US economy fed a runaway stock market and property market bubble. At its peak, the land under the Imperial Palace in Tokyo was worth more than all of the land in California. A hard crash in prices followed this bubble, leading to a deflationary economic slump which Japan struggled to recover from through the 1990s and 2000s. Feverous optimism for owning Japanese assets was quickly replaced with deep pessimism. And the pessimists were right, Japanese asset prices languished for years.
The Nikkei 225, a leading stock index for listed Japanese businesses, did not recover to the highs seen in the early 1990s until 2021. It literally took 30 years for that stock market to recover.
As such, it is unsurprising that the consensus among global investors towards investing in Japan has been cold, for a long time. Why invest in a stock market which has gone sideways for 30 years when you can buy US tech stocks, or emerging markets, or even plain vanilla European equities, all of which massively outperformed Japanese stocks for the past 30 years. And indeed, this sentiment was quite correct, investing in Japanese assets over that period would have been a poor investment decision.
Things could be changing, however, and investors should be cognizant of the opportunity. Today the valuations of many listed Japanese stocks are very low. In many cases, listed companies with quality businesses trade at or even below the value of cash held on balance sheets. Many companies have low levels of debt or no debt at all.
At the same time a new generation of business leaders are emerging in Japan with a greater focus on shareholder returns. Many have been educated in US and European business schools and are introducing some aspects of Western business culture to boardrooms in Japan. This could unlock significant value for shareholders of those businesses.
The Japanese government and stock exchange have also announced that they want to incentivise Japanese companies trading on low valuations to do more to encourage increased investor appetite for their shares.
When we look through stock screens of Japanese listed companies, many of them produce very high-quality products, in some cases with global appeal, yet the stocks trade on very low valuations because of the broader global market perception that Japan is ‘un-investable’.
Some high-profile US value investors, including Warren Buffett, have been increasing allocations to Japan in recent years too, early evidence of a potential positive shift in sentiment.
Things could be changing and investors should take note!
Disclaimer: The views expressed in this article are those of the author at the date of publication and not necessarily those of Dominion Capital Strategies Limited or its related companies. The content of this article is not intended as investment advice and will not be updated after publication. Images, video, quotations from literature and any such material which may be subject to copyright is reproduced in whole or in part in this article on the basis of Fair use as applied to news reporting and journalistic comment on events.
