Following The Legendary Templeton Strategy Full Circle Back To Japan

Includes: DXJ, SCJ
by: Investment U

By Carl Delfeld

Sir John Templeton's strategy was simple and forward-looking. He searched for deep value worldwide, particularly in markets that were greatly out of favor. "It's not easy," Templeton stated, "but if you're going to buy the best bargains, look in more than one industry, and look in more than one nation."

Templeton was way ahead of his time. For example, he plunged into the Japanese market just as it was emerging from the rubble of World War II. He bought just about every share he could get his hands on, and at one point 60% of his flagship fund was in Japanese equities. He did the same thing in Peru in the early 1980s, buying across the board when the country was going through political upheaval.

Though simple, Templeton's strategy requires two attributes in short supply amongst investors: nerve and patience.

You need a bit of nerve to take action at a time when a company, industry, or country is despised. You also need patience to search for bargains, and then wait for markets to recognize the value and growth prospects.

Where would Templeton be looking right now? He might well have gone full circle back to Japan. During the last five years, Merrill Lynch reports that global investors have underweighted Japan to a significant degree. Reflecting this skepticism, the Japanese Nikkei 225 stock Index has lagged world markets by more than a third during this period with a cumulative return of negative 5%.

Apathy by both Japanese and international investors, weakness in key European and Chinese export markets, and an overvalued yen have combined to push Japan's stock market to rock bottom prices. About 75% of the stocks in its broad TOPIX Index are now trading below break up (book) value and, until last week, the market was down eight weeks in a row.

This is despite signs that Japan's economy is showing some vitality. Corporate profits are expected to be up 60% in 2012, and GDP growth in the first quarter topped 4%. And in the first five months of 2012 alone, according to Dealogic, Japanese companies were on the march, spending $35.4 billion on foreign acquisitions. Last year, a record $83.7 billion in deals was inked, including $25 billion on Chinese companies. A lot of these deals were significant but quietly executed. Earlier this month, Marubeni's $5.6-billion bid for Gavilon, a large U.S. grain trading company, was typical.

This flurry of deals is being fueled by a super strong yen that has put foreign companies on sale. But this window is closing, since the Japanese yen is significantly overvalued. And a weaker yen is the catalyst to drive stock prices higher in the face of Japan's well-known debt and demographic headwinds.

Any weakening of its currency will spark a rally in Japan's export-heavy market. But a weaker yen will also unfortunately cut into the performance of just about every Japanese ETF with one exception. The WisdomTree Japan Hedged ETF (NYSE: DXJ) takes currency completely out of the equation.

Next, let's turn to Japanese small-cap stocks, which are even cheaper than Japan's leading multinationals. Japanese small caps are trading at only one third of their total sales compared to 1.2 times sales for Nasdaq. The dividend yield for Japanese small caps is also 2.6%, while it's less than 1% for Nasdaq.

What an opportunity.

Smaller Japanese stocks also have scant research coverage, cash-rich balance sheets and are growing fast by targeting Asian markets outside of Japan. Unfortunately, very view of these small caps trade on U.S. exchanges, so your best bet is the Small-CapJapan ETF (NYSE: SCJ).

I understand that making a lot of money in a short time is the goal of many investors but history makes clear that this attitude is unlikely to build wealth. Gather some patience and begin following the legendary Templeton strategy full circle back to Japan by adding some DXJ and SCJ to your global portfolio.