Nikkei Briefly Touches 6 Year High, But Japan ADRs Lag

The Nikkei 225 topped 17,600 at the start of trading today, reaching a 6 1/2 year intra-day high. Although it went on to close down 0.3% at 17,458 on profit-taking, there seems to be little doubt Japanese stocks are poised to climb higher in '07. Meanwhile, fewer Japan ADRs than one would expect are at 52-week highs, with most having peaked last Apr/May.

One big damper on ADRs (esp. of late) is the weak yen, which is trading near four year lows against the dollar. This has helped the cause of exporters' ordinary shares but limits upside for ADR investors.

Whether the yen gains ground against the dollar will depend on how soon the Bank of Japan raises rates again and if the Fed either holds or cuts rates. Another decision to pause by the BoJ combined with a Fed decision to hike, would almost certainly send the ¥/$ over 125. However, a BoJ follow-on rate hike could send the conversion rate towards 115.

I compiled a list of Japan ADRs that trade on the Nasdaq and NYSE and compared their closing price (as of yesterday) against their 52-week highs and lows. (See chart below -- click to enlarge) A little over half of them (28 total) are within 10% of their 52-week high (understand that some of these are at multi-year and/or all-time highs in Japan).

What stands out is the strength in autos, specifically Honda (HMC) and Toyota (TM), which is not a surprise. Although, I actually like Nissan (NSANY) the best here and have previously suggested it as both a short- and long-term play (see Dec. 12 post, scroll down) -- it has moved up $2 (~8.5%) since then.

Another stock I want to point out is Konami (KNM). It was moving up quite nicely at year-end but has fallen apart so far this year. I like Konami because of the momentum behind Nintendo (NTDOY.PK) and the boost gaming software publishers should get as more supply of new consoles becomes available. Also, Konami trades at a much lower P/E than U.S. gaming software rivals. It is also a play on casino slots.

Among the weakest stocks is Trend Micro (TMIC). Anti-virus software stocks are getting no love and they definitely weren't helped by Symantec's (SYMC) earnings warning. Despite the bearishness, I have Trend on my watch list because I only see threats to PC-related security growing and there's increasing concern about mobile phone security. I like it at these levels. It has a very strong balance sheet and I don't want to be too much of a speculator, but I think given a market cap around $4b, a takeover is not out of the question. In the meantime, for shareholders' sake let's hope there are at least some share buybacks.

Don't be fooled by apparent strength in Mizuho Fin. Grp. (MFG). It has only been trading on the NYSE for a couple of months. Larger rival Mitsubishi UFJ Fin. Grp. (MTU) peaked last May and continues to trade closer to its 52-week low than its high. I support the idea of investing in Japanese banks, especially as they lagged the broader market last year, but I think this is a longer-term play that requires patience.

Despite trading far from their 52-week highs, I continue to hold Internet Initiative Japan (IIJI) and NIS Group (NIS). The latter is definitely a more speculative play, but I am still confident there will be a reversal in its share price. It reports earnings Feb. 5 and that should reset the direction of trading, meaning management and earnings/guidance will either change investor sentiment, or this stock really is in some trouble. The outlook for IIJ meanwhile remains positive and even though the stock is up over 10% from where I began accumulating, I believe there is a lot more upside with both the possibility of a dividend introduction and I wouldn't count it out as a takeover target.

Stocks I don't like on the list include NEC (NIPNY) for its regulatory compliance/restatement issues and because there are better plays in electronics. I am also somewhat bearish on NTT (NTT) despite it trading near its 52-week high. There's a good article in the WSJ's "Heard in Asia" that I recommend reading. It suggests there's upside due to an aging workforce, resulting in fixed cost savings; but there are still too many negative aspects regarding its business such as declining subscribers to its core fixed-line service. There will likely be more cost-competition in telecom, which is good for consumers but obviously bad for NTT, since the market is not growing based on a stagnant population.

Disclosure: The author owns shares of Internet Initiative Japan and NIS Group.