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Market commentary July 2007

By July 6, 2007No Comments

SUMMARY.  Japan has hardly taken off in 2007, but there is increasingly good value in their smaller companies, some of the best value to be found anywhere in the world.
P.S. Two housekeeping points: the latest TopFunds Guide should be available next week, so please email back if you would like a copy; re online valuations, please follow instructions in our last email to access the new on-line valuations facility.

Earlier this year we suggested that Japan could be the surprise package of 2007.  So far the Nikkei 225 is up 5%, underperforming the UK and the rest of the worlds stockmarkets, so not yet a lot of excitement.  But if you are a contrarian, Japanese smaller companies are compelling.

Some historical context is required.  The Japanese stockmarket began to recover in 2003, after a horrible 14 year bear market, when the main index fell from 39,000 to 7,700.  The recovery ran too far too fast and by early 2006 valuations for smaller companies in particular were stretched.  Interest rates went up at a time when concerns began to build over US economic growth, this coincided with the Livedoor scandal, and smaller companies fell by up to 50%.

Despite a continuing economic recovery, small cap share prices have still not begun to recover, though there are signs of stabilising.  Yet company profitability is encouraging, with a fair number announcing profits above expectations.  You may recall that on prior occasions we have considered the relative merits of a stockmarket or individual share based on its “price earnings ratio”.  It’s certainly not a perfect measure, but it helps, and the guide is that the lower the ratio, the better the value.  Price earnings (PE) ratios for Japanese smaller companies are about the same as in 2003, at the bottom of the 14 year bear market.  And a number of fund managers are telling us that they are uncovering profitable and stable businesses on single digit PE ratios, which suggests fantastic value compared with much of the rest of the world.

It is also encouraging that whereas Japan’s main small cap index (Jasdaq) was 5.6% owned by foreign investors a year ago, this has now soared to 23.5%.  Whereas in 2005 foreign interest was dominated by hedge funds, now the buying appears to have been by fund managers with a longer time-frame.

The attractiveness of the sector was confirmed earlier in 2007 when GE purchased Sanyo Electric Credit at 60% above the stockmarket quoted price.  And don’t overlook that the yen is possibly 30% undervalued, and when this turns it will give another positive kicker to performance.

Japanese smaller companies are not a short term punt, but rather something to be tucked away for a while, and certainly for those with strong stomachs and a robust attitude to risk.  Consider Axa Framlington Japanese Smaller Companies and M&G Japanese Smaller Companies.

Dennehy Wealth