Japan Value: An Island of Potential In A Sea of Expensive Assets
Global stocks and bonds are both expensive. U.S. stocks are trading at particularly elevated valuations with the CAPE ratio standing at 35x (vs. a 10-year average of less than 27x) while the Barclays Bloomberg U.S. Aggregate index offered a negative real yield at the end of February. No wonder investors are scouring the earth for attractively priced assets and alpha opportunities. We believe Japan Value and Small Cap Value stocks offer both – a compelling beta opportunity with room for active investors to add value.
We’re excited about Japan Value equities for three key reasons. They offer:
1) attractive valuations;
2) a supportive secular transition of rising profitability and more shareholder-friendly policies; and
3) fertile fishing grounds for alpha seekers.
Japan Value and Small Cap Value Stocks are Cheap
As in other markets, Japanese stocks have risen strongly during the post-Global Financial Crisis cycle. Since the end of 2012, the TOPIX has delivered 12% annualized returns – stronger than ACWI, though trailing the exceptional 15% returns in the U.S. While this has left valuations of Japanese equites stretched relative to historic norms, they do look attractive compared to the U.S. Japanese equities offer higher earnings yields (i.e., cheaper valuations) and stronger expected earnings growth over the next two years.1 Of course, for anyone looking to compound absolute wealth, relative comparisons offer faint praise.
Fortunately, Japanese equities aren’t homogeneous. Value stocks have underperformed dramatically in Japan as they have in other regions for years, leaving their valuations compelling. In addition, while small cap companies have rallied strongly in the U.S. and emerging markets over the last few months, they have not in Japan. Per Exhibit 1, Japan Small Value stocks, which normally trade at a 25% discount to the market, are now sitting at a whopping 46% discount.