Japan Severely Oversold By Historical Valuations

Like a dam breaking, market sentiment has collapsed from cautious optimism to fear. Based on the MSCI Global indices, global markets are already down 7% to 12% this year, and the US stock market is finally beginning to discount a recession in earnest.

The current economic environment, as was succinctly summarized in a recent World Bank report, is facing a period of “increased uncertainty" and several "serious downside risks" which may prevent a soft landing for the global economy. Japan on the other hand was already suffering from a ”kanryo fukyo” (bureaucratic regulations-instigated recession), while the real brunt of a subprime toxic waste instigated global slowdown has already hit the export sector pretty hard.

Thus the question is, is this a “normal” cyclical recession or something more serious? At this point in time, investors have no way of knowing. If we were pressed to guess what maximum downside risk for the Nikkei 225 is under a worst-case scenario, we would have to say “10,000”, which would take us back to 2004 levels.

However, what we can say for certain is that Japanese stocks have clearly entered oversold territory vis-a-vis historical valuations, and vis-a-vis its global peers, including the emerging markets. Moreover, the P/E is at a 37-year low、the dividend yield is above the JGB (long bond) yield, and the Topix as well as the TSE 2 are now selling at less than stated book value. The biggest PBR discounts are now in banks, metal products, construction, insurance, pulp/paper, textiles/apparel, other finance, wholesale, rubber products, oil/coal, warehousing and mining, in that order.

As ROE is also roughly half these regional indices and dividend yields are also almost half as low, Japan will have to raise dividend yields, profitability and/or expected growth rates in order to dispel current accusations of "value trap". However, market action over the last couple of days (i.e., an intraday move of in the Nikkei 225 some 530 points on Friday) strongly suggests that the market is trying to find a bottom.

Disclosure: Author is long GLD.