To The Moon

The Bank of Japan has a new governor, Kazuo Ueda, and two weeks ago he held his first press conference. The result was a rising stock market and a falling yen. Ueda promised to be cautious about policy adjustments. That policy consists of a price ceiling on 10-year interest rates. The Bank of Japan buys up all bonds above that price ceiling. Normally then the market does the work for the central bank and interest rates do not rise above that price ceiling. But since the Bank of Japan raised that price ceiling from 0.25 percent to 0.50 percent in late December, there has been plenty of speculation since then that the Yield Curve Control policy is finite. For now, the surprise that interest rates will remain low for a little longer was good news for the stock market, less good for the yen. The market accepts Ueda's policy given the normalization of the yield curve. According to some analysts, Ueda's words should be interpreted to mean that the Bank of Japan will not make any changes at the next meeting in late April and that there will be room for adjustments later this year. Ueda adds, however, that more time is needed to get inflation in Japan structurally toward 2 percent. In the rest of the world, this means that the problem is that inflation is structurally too high; in Japan, inflation is structurally too low. That makes Japan interesting for investors, there are few countries where more inflation would lead to a positive outcome. That the Japanese stock market is attractively valued has also caught the eye of value investor Warren Buffett. Several years ago he already built up stakes in four vertically integrated trading houses (Itochu, Marubeni, Mitsui and Mitsubishi), but last Tuesday he indicated that he wants to further expand his holdings in Japanese companies. Japanese trading houses are often over 100 years old and conglomerates that invest in everything. In that respect, they resemble Berkshire Hathaway. Except that Buffett's Japanese shares have doubled, while the Nikkei has risen 20 percent at the same time. That's because, like Berkshire Hathaway, these companies are a good hedge against rising inflation. Mining (for example, Mitsui has a 6 percent stake in Vale de Rio Doce) and energy shares are relatively high. Still, these companies trade around their book value and the dividend yield is at 3 percent, a multiple of Japan's 10-year interest rate. The Japanese stock market (Topix) is trading at 13.3 times earnings, and the S&P 500 at 18.9 times. On balance, Japanese companies are still debt-free. Much has been done in recent years to improve the profitability of Japanese companies. That was the hard part, now only earnings per share need to go up and that is the easy part. The balance sheet has to be optimized. Japanese companies need to borrow money to buy back shares and pay dividends. This makes Japanese stocks less dependent on the global economy, but may well see some interim catch-up in terms of stock prices. Consequently, it is not that far down to the all-time high of the early 1990s. Added to this is the recovery potential of the now severely undervalued yen.