01.24.2012
By Terry Flanagan

Slowdown Ahead for Japan?

Fundamental investors have made a case for Japan while those who are bearish on the country’s economic outlook may now prevail.

To the chagrin of some investors, geo-political catastrophic events have often weaved their way into the markets. Last year’s Japanese tsunami and following nuclear disaster serves as a primary example of the lasting toll that such events can take.

While short-term event-driven traders may have turned negative on the country, long-term, bottom-up fundamental investors see the glass half-full with cheap buying opportunities and favorable valuations.

del Rey Global Investors, a Los Angeles based 1.4 billion asset management firm, is primarily focused on large-cap international equities. The firm’s 1.1 billion Monarch Fund has taken large positions in Japan. As of December 31, 2011, three out of ten of the top holdings were Japanese—Seven & I Holdings, Mabuchi Motor Company, and Dai Nippon.

In the third quarter 2011 investor letter, Paul Hechmer, founder and chief investment officer of del Rey wrote, “We’re finding great valuations all over the place… Japan remains chock full of them.”

Indeed, Japan had performed much better than other parts of the developed world at this time—mainly, the Eurozone.

The third quarter was so negative for Europe that Japan—as measured by the Topix Index—ended the third quarter up 10% versus the Eurozone—as measured by the Bloomberg Euro Stoxx 50 for 2011, noted Hechmer.

However, recent news that Japan is steering away from its exports driven economy to one of deficits, incurred by a high-performing yen may be detracting from fundamentalists’ positive sentiment on the country’s cheap opportunities.

The Japanese government is reportedly expected to announce on January 25 that the country has experienced its first annual trade deficit since 1980.

Market observers strongly attribute the slump to macro events such as the earthquake-led tsunami which destroyed factories, and supply chains. Only time will tell if Japan-centric investors will feel the impact of such macroeconomic events affect their outlook on Japanese company valuations. For Hechmer, the recent negative economic news should be recognized, but told Markets Media that cynics “could find plenty to fret about elsewhere around the world. ”

“Japan has looked inward for so long that they are now simply incapable of competing on a global scale,” Hechmer said. “Many of their problems are inherently very fixable – allow immigration to relieve their shrinking population, allow hostile take-overs to force companies to be run more competitively. But there’ll be a lot of inevitable pain first. But over time, economics will work again.”

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