Episode #256: Best Idea Show – Jeremy Schwartz, Jesper Koll, WisdomTree, “Japan Is Trading At The Lowest Valuation In 30 Years”
Guests: Jeremy Schwartz serves as WisdomTree’s Executive Vice President and Global Head of Research. Jesper Koll serves as Senior Advisor to WisdomTree.
Date Recorded: 9/3/2020 | Run-Time: 44:16
Summary: In our inaugural ‘what’s your best idea’ episode, we’re covering their best idea: Japanese stocks. We get a bit of history on Japan’s past boom and bust cycle and the way it has shaped attitudes toward risk and investing in the country. We talk about Japan’s corporate culture, and how it has changed over the years.
We discuss the opportunity the Japanese stock market represents on the basis of fundamentals as the stock market now trades at the lowest valuation in 30 years, and what it’s going to take to get the market moving. We even get into the recent positions Warren Buffett has taken in a few Japanese firms.
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Links from the Episode:
- 0:40 – Intro
- 1:59 – Welcome to our guests, Jeremy Schwartz and Jesper Koll to the show
- 2:25 – The Meb Faber Show – Podcast Episode #26: Jeremy Schwartz, “You Should Be Hedged a Lot More Than You Are”
- 4:32 – Best idea right now
- 6:22 – The 80’s Japan Boom vs the US 90’s dot com boom
- 9:46 – Investment sentiment in Japan today
- 13:38 – How Japanese companies view corporate equity moves
- 15:50 – Investor activism in Japan
- 18:54 – How interest rates impact the investing landscape
- 21:24 – How Warren Buffett and Charlie Munger are getting involved in Japanese companies
- 25:19 – How they’re implementing their currency strategy
- 28:33 – What other catalysts drive the Japanese markets
- 30:48 – Risks to the Japanese trade
- 32:47 – Easy ways to invest in Japan
- 33:24 – Composition of the fund
- 36:20 – Small and midcap section of Japan
- 37:49 – The lack of headline breaking companies and executives
- 40:59 – Visiting Japan
- 42:38 – Learning more: wisdomtree.com, Blog, Jesper’s Blog, Jeremy’s Blog, Fund Comparison Tool
Transcript of Episode 256:
Welcome Message: Welcome to the “Meb Faber Show,” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Meb: Hey, podcast friends, today we are introducing a inaugural episode, special segment of the podcast called “What’s Your Best Idea?” We’re gonna dig in deep with our guests to talk about their best investment ideas right now. They’re gonna give you a front-row seat to the research and thinking on a singular idea or concept, as well as their take on some fresh actionable ideas. Today’s guests are two of WisdomTree’s brightest minds. One serves as executive vice president, head of global research, and is a podcast alum, and the other is head of Japan.
In today’s episode, we’re covering their best idea, Japanese stocks. We get a bit of history on Japan’s past boom and bust cycle, and the way it has shaped attitudes towards risk and investing in the country. We talk about Japan’s corporate culture and how it has evolved over the years. We discuss the opportunity the Japanese stock market represents on the basis of fundamentals as a stock market. Now it trades at one of the lowest valuations of the past three decades. And what’s it gonna take to get that market moving. We even get into the recent positions Warren Buffett has taken in a few Japanese trading firms. Please enjoy this special best ideas episode with WisdomTree’s Jeremy Schwartz and Jesper Koll. Jeremy, Jesper, welcome to the show.
Jeremy: Meb, thanks for having us.
Jesper: Thank you.
Meb: You guys are the inaugural “What’s Your Best Idea?” episode, hopefully, it’s not the last. Hopefully, there’s a lot of fun and people love it, we’ll see. Well, the format’s gonna be a little bit different, listeners. We’re gonna focus in on one idea. We don’t know what it is yet, we’ll find out. But we’re gonna cut it a little short on the background because you guys have heard Jeremy before. If you haven’t, you gotta go back to an episode in the archives, you’re gonna hear us rapping at length.
Jesper, though, we don’t know. We got Jeremy in Philly, which, by the way, was the last place I was supposed to be pre-quarantine for the Democratize Quant Conference and a NBA game, and then it all got canceled. So hopefully in the future. But, Jesper, you are on the ground where? Give us boots on the ground update on where you are in the world.
Jesper: I am in Tokyo, Japan, and been stuck here since 1985. So basically around 35 years. I’m originally from Germany but made Japan home first to do some work on a Ph.D. for Hopkins University. And then I got involved in Japanese politics, and economics, and finance. Was the head of research for JP Morgan and Merrill Lynch. And then set up the WisdomTree office here in Tokyo, and I’m now the senior advisor for Japan for the great house of WisdomTree.
Meb: Where’s the office in Tokyo? Are you in Shinjuku, Shibuya? Where are you guys located?
Jesper: No, look, the office is very close to the Tokyo station there. And it’s been fantastic because throughout this COVID crisis as it were, I mean, Japan has been very, very pragmatic. There hasn’t been a single day when I haven’t been outside, many of the restaurants stayed open. Now there’s even a couple of bars here in the neighborhood that adjust the price of beer depending on how many cases there are in Tokyo. So the price varies between 160 yen and 400 yen. So it’s kind of nice.
Meb: Some of the sneaky best are Japanese beers and even the classic drinkable Asahi. I think an Asahi is a top 10 beer for me. There’s a big new microbrew culture, though, in Japan. We were talking before the recording went on about Japan has a soft spot in my heart, it’s one of my favourite ski destinations in the world. Some listeners have been hearing me talk about that. Sadly we’ll not be going in 2020, but maybe 2021. All right, gentlemen, we got a double guest podcast, but I’ll kick it back to you. Let’s hear, what is your best idea right now?
Jeremy: Well, maybe I’ll start and get Jesper to fill in. I think you have timely, Jesper is in Tokyo, we’re gonna talk Japan. The idea timely-wise, it’s been a U.S.-dominated market, a tech-dominated market, growth versus value. Japan is trading at the lowest valuations in 30 years and you now have one of the pristine value investors, Mr. Buffett, coming in buying 5 Japanese stocks, the trading companies. And I think that’s sort of a voting confidence of that there’s good values around the world. And particularly, he’s identified these interesting companies, but you can get a basket of Japanese companies. The 5 companies he bought have a price-to-cash flow yield of around 25%, 4 times price-to-cash flow.
But if you look at one of our flagships for Japan DXJ, the average price-to-cash flow is 20%. So it’s a slight discount, it’s like premium price-to-cash flow number, but it’s still cheap. And you don’t have to buy just five companies, you can get a broader portfolio of Japanese companies tied to global growth. And so our favourite, we think Japan is a good place to be.
Meb: It’s interesting because you touched on a few topics that you and I have been talking about for many, many years, one of which is global investing, value investing, and a lot of people just…particularly on the shores in the U.S. just haven’t been that interested. And they have another reason to because the U.S. stock market has taken a stomp on everything. But you may see some changes happening right now. The U.S. dollar has been struggling over the past six months, you’re starting to see, as you mentioned, some shifting sands, we’ll see if it changes, who knows. But it’s pretty rare for the U.S. to outperform an equal-weighted or global basket of countries like it did for the past decade.
Jesper, let’s kick it over to you. You’ve been in Japan for a while, you’ve seen some pretty different cycles going on, the boom in the ’80s. Let’s walk back just a little bit because I would love to hear someone who kind of experienced that time. How does that compare, do you think, to the U.S. internet bubble? Was it two times as awesome and fun or where does it rank on the all-time booms?
Jesper: Look, a boom and a bubble in Tokyo, which is what we had in the late 1980s you know, it’s just an enormous amount of fun to be had there. And we all can tell stories of… I mean, to flag down a taxi, you had to put down 10,000 yen note in your hand, otherwise, the guy wouldn’t even look at you, right. And didn’t matter whether you were foreign or Japanese. Was a lot of fun during the bubble here.
But obviously, the real lesson of our generation, probably the Japanese bubble was the first bubble, you know, the consequent failure, the consequent collapse of the bubble, the fall into deflation, and really a complete loss of confidence off the Japanese. You know, we all know, that took basically 20, 25 years to work its way out of the system. And the one thing that is actually interesting and it’s a big contrast to, I think, the United States, I mean, remember the Japanese authorities, the Japanese elite bureaucrats and politicians, they actually consciously burst the bubble. I remember in December 1989, when the Nikkei was trading at 40,000 or just shy of 40,000, you got a new central bank governor in Japan.
And at his opening speech, he said, “Well, thank you very much for appointing me to this prestigious position.” And the second sentence was, “Bad things are happening in our country.” And he said the following, he said, “A graduate from the best university entering to work for the best company in Japan can no longer dream of ever being able to afford to buy an apartment within a two-hour commute. This is bad, this is a bubble, and I will burst it.” And then remember they hiked interest rates from 3% to 8% within six months, and boom, you know, that killed the bubble.
But I just wanted to sort of point out that where the Japanese are a little bit different…and I don’t wanna say it’s sort of a socialist economy or anything like that. But the ruling elite, they did burst the bubble very consciously. There was none of this Greenspan type stuff, “Oh, we never know when it’s a bubble, we only know in hindsight.” The Japanese knew it was a bubble and they knew they were gonna kill it and kill they did.
And the interesting thing is, just to chime in here now to set a baseline why Japan is great, do you know that Japan, Tokyo is now the only major city in the world where if you work at a Starbucks, on that Starbucks average salary, you can afford to buy an apartment within a 45-minute commute from downtown Tokyo? That is impossible in Los Angeles, in Shanghai, in Berlin, in London, etc. So the irony is that after 25 years of the post-bubble workout, of 25 years of deflation, now, things are actually affordable, and most importantly, they’re affordable for the young generation, for the people in their 20s here in Japan. That’s the great entry point that you actually have for Japanese assets in general.
Meb: It’s been an interesting couple of decades certainly regarding not just the Japanese markets and the bond markets too, but also the economy, but the sentiment. Last time I was over there I did a little meetup and we were chatting with some local Japanese investors as well some expats. What is the sort of general mood or sentiment when it comes to how people think about investing? Has it changed over the years? Is it seeing any sort of differences? Any thoughts?
Jesper: Yeah, there’s absolutely no question that there’s a big generational divide. The baby boom generation is still scared, they still don’t wanna put money down. In fact, they are hoarding cash like they’ve never hoarded cash before. The people over 55, over 60, no question, they got burned during the bubble, their jobs were put at risk during the bubble collapse, they saw deflation of the house prices, they’re not taking any risks, they’re being very, very careful. And fine, that’s a big chunk, that’s about 25% of the Japanese population.
The interesting thing is that a young generation, people in their 20s, in their early 30s, are actually stepping up to the plate. They realise that earning…you’re putting money on deposit, doesn’t earn you anything, zero interest rate. They know that the government pension fund, you know, is probably unlikely to provide for them for their retirement. And so as a result of that, you are actually seeing a gradual increase in the participation, direct participation in the equity market, as well as in the real estate market by that younger generation of Japanese.
You can be very specific, for example, when you look at self-direct investment, you find that the big four direct brokers, like SBI, Monex, Security, Rakuten, they have seen over the last year a more than threefold increase in the number of new accounts that have been opened. And they are now collecting client money at about twice the rate that the traditional retail brokers, Nomura Securities, Daiwa Securities are collecting it. So slowly but surely, we’re seeing this generational shift, you’ve got the young Japanese in their 20s and 30s getting better jobs, actually, and recognising that, “Hey, I gotta take my financial future into my own hands.” And as a result of that, you’re actually starting to investment.
It’s a push me pull me in terms of the participation here, but I think over the next five years, obviously, the Mick Jagger generation, the baby boom generation is gonna die off some more, there’ll be this wealth transferring to the younger generation via inheritance. And the younger generation is actually stepping up to the plate.
Meb: Jeremy, you and I have talked about Japan specifically over the years, your mention of some valuation metrics. You know I got a soft spot for the CAPE ratio, and Japan is always my poster child for valuation discussions because it hit…I think it’s the highest we have in our historical database of almost 100, 10-year PE ratio in the ’80s. And it’s now back down to, if I had to guess, 20 maybe, so a totally normal valuation. And just for context, the average historically is around 17 for markets in the U.S. and its little bubble hit 45 in the ’90s, but is back up in the…well, depending on what any given day is happening this week, is in right around 32. So it’s trading at probably at least a 30% discount on that metric.
But you also talk about a lot of metrics because you guys build a lot of your funds bottom up. Tell me a little bit about Japanese companies decades ago maybe didn’t have as much of a culture of buybacks of corporate… What’s the right word, activism?
Jeremy: Corporate governance and shareholder, yeah.
Meb: Yeah. Tell me a little bit about sort of… Jesper, you can chime in too. Sort of what that looks like and the changes made and also feel free to talk about all the other valuation metrics too.
Jeremy: One of our bullish points for the thesis is corporate Japan has changed, and you heard of the government [inaudible 00:14:09.357] by the Bank of Japan, the Bank of Japan created this JPX-Nikkei 400 Index that was trying to reward return on equity and get companies to increase return on equity. I go to Japan to see Jesper, and you’d see return equity on the front page of presentations and they have huge amounts of cash stuck on the bounty. So one of the things we talked about, it was surprising, Japan is one of the more volatile segments of the market almost trades like an emerging market in the sense of its levels of volatility in Japan.
But because of these huge cash amounts, it was actually relatively more stable during this pandemic, and I think part of it is the huge cash amounts. But they are increasingly taking the cash and paying it out in dividends and buybacks. Now, we hear buybacks a lot in the U.S. The U.S. is a far outlier. We now do more net buybacks in the S&P 500 than we do dividends. The dividend yield is down like 1.6, 1.7. I’m looking at it right now, as of July it was 1.8%. The net buyback was basically equal, it was also about 1.8%. So about 3.6 dividend buybacks in the U.S.
Japan, I’m gonna stick with DXJ, had a 3.5% dividend yield and a 1.4% net buyback, which, for international markets, you don’t see 1% net buybacks. I don’t think there’s another international country outside the U.S. that has 1% plus as a whole for… Obviously, individual companies will, but as a whole, I don’t see anybody that has a 1% plus net buyback. So getting 5% plus total shareholder yields, around 5% for DXJ, which is a 1.5% ahead of the S&P, if I’m doing that math, right, I mean, it’s a real opportunity there.
And the companies are, even with the earnings slowdown, Jesper talks about the buybacks and dividends continue, they try to maintain the dividend. And I do think corporate Japan has changed. And there’s still a lot of cash on the balance sheets that can support even further growth. I think there’s more cash up to do there.
Meb: Jesper, have you seen any noticeable difference in the attitude of corporate leadership, of investors’ activism over the years, and what were kind of the driving factors?
Jesper: I think you put your finger on the pulse there. I mean, why do you buy a company? Why do you make an investment? There’s something that you like about the company, they’ve got a product that you like, which is fine. And we can debate endlessly whether Japan is still innovative or not. I think people who play “Animal Crossing” would swear by Nintendo any day. There’s plenty of innovation there, but you gotta pick that right. But it’s absolutely right, that corporate Japan did not care about shareholder return.
And I remember when I was working with Julian Robertson at the Tiger Fund, we used to visit these companies. And of course, Julian Robertson, one of the great investors in the world, you know, would always ask, “Oh, what’s your ROE?” And there would be a lot of sucking of thumbs and going through the pamphlet, and then they would say, sort of, “Oh, it’s 32 basis points.” Completely, they didn’t care about the cost of capital, and they didn’t have to care because corporate Japan was an insider’s club. It was the Mitsubishi Group, the Sumitomo Group, it was the Mitsui Group holding their shares in this cluster, holding structure. They didn’t have to worry about generating capital returns for you because you were all part of the team.
This has changed. The cross-shareholdings have broken down, they went from slightly over 50% of the market cap in the early ’90s, down to 4%. So Japan has actually moved from being an insider’s market with these cross-shareholdings to actually being an open outsider’s market. And then what happened is, under Prime Minister Abe, one of the first things that he did is reform the world’s largest pension fund, the GPIF, the government pension fund here in Japan. He put in an outsider, and all of a sudden that outsider, Mr. Mizuno, the CIO, started to demand from companies, “Why are you not raising your dividends? Why are you hoarding cash? Why are you holding this investment? It makes absolutely no sense.”
So it was actually not a bunch of foreign activists coming in, a bunch of black ships coming in demanding higher dividends, or share buybacks, or setting off of non-core businesses. It was actually…over the last eight years, it was the domestic biggest pension fund, the government pension fund, that started to hold management accountable. And that’s what’s exciting and that’s exactly where you are right now.
And so you ask what the mood is amongst the CEOs, now you and I going into any company meeting, whether it’s Hitachi Corporation or whether it’s a small or mid-cap one, the first thing they talk about is, “This is our weighted cost of capital. This is how we’re gonna beat it. This is how we’re going to generate returns.” That’s exciting. That’s a big shift in the way the market works and the way corporations work. The goal is now aligned with the investor.
Meb: You can feel sort of the sentiment changing just in general discussions in the media as well. I wonder how much of the macro situation with Japanese fixed income over the years was something that just caused people to be a little squirrely about what’s going on now. Now, in 2020, we live in a world…Japan is like a high yielder compared to some of the sovereigns out there.
Jesper: I love your point on that. And just because we’re all bad now, and we all have zero or negative interest rates now, that doesn’t make it comfortable. But at least Japan is no longer the weird one out there. Oh, my God, they’re monetising debt. Well, so is Mr. [inaudible 00:19:32.618]. I mean, everybody is doing it right now so it has leveled the playing field.
And one of the greatest things that happened actually, in Japan, is you remember Paul Krugman, always very aggressive, very opinionated. And he had lots of opinions during the 1990s. “Oh, the Japanese are silly, they should be doing this. They should be doing that.” It’s easy to get out. And then when the U.S. had its global financial crisis, sort of a year in, he wrote a letter of apology to Japan. He said, “Oh my god, I now realise it’s very difficult when it’s not a textbook case, but it’s actually a real-world of deflation, a real-world of debt deflation, a real-world of loss of confidence.”
So that was very, very nice. So you’re right, Japan is now one of them. And so the question is, what are my core strengths? And what is my valuation entry point? And I think the fact that Warren Buffett just committed $6 billion to Japan, okay, that’s a bell going off. It’s like, hello, yes, Japan is a value proposition. But he’s also confident in making that $6 billion investment in Japan because he knows that the management of those corporations now actually works for him, the investor, rather than just for the inside Japanese group. So I think the two together, I think, make a very, very exciting entry point.
Meb: As I was preparing for this, I was looking at some charts of Japanese stocks and bonds, I found an old post of mine, I’m gonna have to tweet it tomorrow from 2012. 2012, it is an article where I lined up Japanese bonds and U.S. bonds, and in the article, 2012, I said, “Can you fathom U.S. 10-year bonds yielding 0.5%?” And I said, “No.” And then I described what happened in Japan. And so I gotta pat myself on the back. Now, I didn’t go buy a bunch of 30-year at 0 coupon bonds, I should have, I could have retired, but anyway.
Okay, so you mentioned Uncle Warren and Charlie, this is pretty telling, why don’t you guys give us a summary of what they’re up to? I know, most people saw the news and they’re probably like, “What are trading companies? What are they described as?” They heard the news they’re like, “What is he doing over there? Is this one of his little tenets?” I’d love to hear you guys just thoughts on what’s the why behind his thesis and how is he expressing that actual trade?
Jesper: Jerry, you go ahead with the valuations.
Jeremy: Well, I think the clear case on the stocks being, there’s the 5% to 6% dividend, so he’s gonna get a nice basket of income. And they actually are doing buybacks as well. So you’re getting very high combinations of dividends and buybacks. And so I think he did that. And I also have a speculation he issued 430 billion yen of debt last year, I don’t think he’s had any real business case, I haven’t found a real reason to do the debt. And so he’s financing that with these yen-denominated bonds. So he’s basically getting a huge carry trade on that.
And then you say, “Well, what is he getting?” And Jesper, you know the businesses as well as anybody, so maybe you could talk through how you see through the inflation angles, the other angles that you think of why those particular valuations are attractive to him.
Jesper: Yeah, I mean, look, the Japanese “sogo shosha,” the trading companies which Warren Buffett bought the five biggest ones, they are general trading companies. Their business and their share performance, basically, is very cyclical and it swings up and down with commodity prices. And they’ve got businesses all over the world, whether it’s from soybeans all the way down to iron ore, they do big project finance. And they also do a lot of venture capital and M&A type activity here.
So number one, buying the “sogo shosha,” buying the general trading companies you’re buying a gigantic inflation hedge. And you can do that, as Jerry explained, with a positive carry. Number two, you’re buying a ringside seat for all M&A and venture capital activity in Japan and a lot in Asia. So that’s fantastic in terms of getting access to innovation and to new companies coming through. And then last but not least, we do have this increasing tension on technology, in particular, between China and the United States of America.
So if American companies can no longer source or do business with Chinese corporations, they’re gonna have to go somewhere else. Where will they go? They will go to Japanese companies. And it’s exactly the trading companies that will broker those deals coming through. So it’s, you know, a big inflation head, a ringside seat at the frontier of innovation and venture capital in Japan and Asia. And it is a risk diversification because the trading companies benefit from the U.S.-China technology war.
Meb: It’s also interesting as far as his position sizing because isn’t he limited to a certain percentage? Like he bought probably as much as he could have in those companies. Am I getting that broadly right for Buffett?
Jesper: Yeah, you’re right, he basically owns now between 5% and 10% of these companies. Once you go over 10%, it gets a little bit complicated. You gotta get clearing for national security reasons and all of that. No doubt he could get that, but it’s just, why would you really wanna do that?
Meb: Yeah, he’s like, “I’m 90, I’ll just buy a basket of them.” We’ll send them this recording, “You should have just bought DXJ.” Does that own any of these sorts? Does that have any of these in the index?
Jeremy: DXJ is a dividend-weighted portfolio. These be stocks have an average DVO to 5.8%.
Meb: 5.8, gone are those days in the U.S., 5.8.
Jeremy: Right, it’s a high yield basket, and so we’re overweight these stocks, the MSCI Japan has a little bit….close to 3%, we’re almost twice the weight there.
Meb: You guys, Jeremy, you guys had a long history at WisdomTree of being pioneers. And often, I think, non-consensus on how you think about currencies, I think, and often right. Will you tell us a little bit about the thesis behind how it’s implemented DXJ with a currency and any general thoughts there too, because it seems like Buffett is playing a similar game?
Jeremy: I don’t wanna say that I know for a fact this is how he’s doing it. I’m speculating this is why he’s doing it. I actually tried to reach out for comment and haven’t really heard anything. But if he issued this 4 billion yen of yen-denominated bonds, when the yen goes down in value, he’s gonna owe less back a debt in U.S. dollar terms. And so he will because when he sells his dollars to buy yen to buy the stocks, he has yen exposure, inherently being long the stocks and long the yen, but if he’s buying the stocks, why bet on the yen? Being long the yen is not central to his thesis.
If you’re saying, “I just wanna buy the stocks because they’re cheap stocks,” why make the secondary bet? And that’s been one of my big points on currency, generally, is I think international diversification is important, I don’t think it means the dollar is gonna go down forever. And now the last big stretch of the dollar going up the last few months, dollar is going down, but nobody really knows where the dollar is gonna go. And I can make a very compelling case that being currency hedge is better diversification going forward than historically.
And I say that because now the S&P has a short dollar bet into all the earnings. Our earnings increasingly come from abroad and a strong dollar hurts our earnings. And a strong dollar helps Japan, a strong dollar helps Europe. When the Europeans see the euro going up, they get scared, you start to have ECB, officials start talking it down because a strong euro hurts them. And so there’s definitely the case… A lot of people think being long, these foreign currencies are diversified, I actually disagree with that.
So I think for Japan, it’s like I just wanna be long these stocks, I don’t wanna care about the yen. Maybe the yen pops up after all this money printing one day and the yen shows up at 141.50, and who wants to be exposed to that? You just wanna buy cheap stocks.
Jesper: Well, you get paid for that.
Jeremy: And you’re getting paid. I mean, now there’s a little bit of the carry trade as well. So people would say, “It’s expensive to hedge.” I’d say yes, it’s expensive to hedge Brazil, it’s expensive to hedge South Africa. You’re paid to hedge the euro, you’re paid to hedge the Swiss franc, even more, been paid to hedge the yen. And so you do get paid a bit to hedge the developed world currencies.
Meb: There’s some areas that I’m extremely opinionated on and others that I’m not. And I’ve always enjoyed chatting with you about this over the years. Because I fall into this somewhat agnostic camp here, I totally understand the argument because you’re always like, why…you’re combining two bets rather than just one. And the reality is that real currency returns over time tend to adjust for inflation unless you have a strong feeling on where the currencies are going. So I can see it.
What else? What do you think starts to draw the interest? I mean, Buffett is obviously…I mean, if you were to do a laundry list before Buffett, that would be probably in like the top five of sentiment of getting people interested in the Japanese story. But let’s say Warren hadn’t done this, what other sort of like catalysts, themes other than just simple valuations, what else really gets these markets moving?
Jesper: I think…and if I chime in here, I think at the end of the day, it’s straightforward, it’s just visibility of earnings. Your starting point is attractive valuations, so the question now is, are we gonna get a positive revision cycle in terms of revisions of earnings being above whatever the analysts, whatever the consensus is out there, or are we gonna stay stuck in this cycle? And actually, in Japan, we’ve been in for a year and a half. It’s been a year and a half, where the actual reported earnings came in below the corporate guidance or the consensus estimations.
And actually the last quarter, the April to June quarter, which is a weird quarter anywhere in the world, already there, we saw positive surprises outweighing negative surprises by a factor of about almost 20%. And the reason…and this is why the macro play in Japan is exciting and interesting, is Japan now is linked at the hip to the People’s Republic of China. And whether you like it or not, I’m not a fan of the Communist Party, but I love the way they manage their economy and I’m sorry, it is a V-shaped recovery.
Last week, I was out visiting some Japanese capital goods companies, like FANUC or NAPESCO, orders from the People’s Republic of China up 20%, 25%. So that part of the business exposure, which accounts for as much as almost 40% of Japanese earnings come from the People’s Republic of China, exports or production there. That drives the positive earnings surprises, and that’s I think what unlocks the value proposition and turns it into a growth story.
Jeremy: So much of Japan’s biggest companies are the car companies like the Toyota. And in some ways, I almost think, you know, if Buffett is number one, it’s like the Tesla versus Japan trade, that Tesla is dominating all these car companies. And the amount of production you get from Toyota versus Tesla is like crazy. And then you’ve got Tesla at how many multiples of Toyota’s market cap?
Meb: That would have been a good trade today. The long… Every other car manufacturer is short Tesla trade. Is there any sort of political risks upside and downside of just Japanese politics? I know, we may be in a post-Abe world of…in the future, is there any sort of risk of this trade or investment that would cause it to sort of be less enthusiastic, anything come to mind?
Jesper: If the world really started to shut out China completely, that obviously would be a big negative for all of Asia, and quite frankly for a lot of the United States as well, but that’s anybody’s guess here. I mean, there’s politics, there is how do we get China to play by the global rules, etc., etc., and then there is the business reality. I mean, if you and I run a Japanese company, you and I run a Korean company, I mean, trust me, our best business partners are the ones no longer in the United States, but are the ones in the People’s Republic of China.
And look at American companies themselves. I mean, you’ve seen the data. Despite all this political grandstanding, foreign direct investment by the U.S. into the People’s Republic of China rose to a new record high in the first six months of this year. Elon Musk is building a factory where? In China, and in Berlin. I know Berlin sounds sexy to you and me, but China is the biggest of the biggest giga factories because that’s where the market is.
Meb: I think I saw some pictures on Twitter of Elon dancing around in some lederhosen today. Oh, gosh, no comments. So implementation should be easy for this idea, given we’ve kind of mentioned one of the ways to put it to work. The interesting part is this has been…I mean, I think it’s still a billion-dollar-plus fund. DXJ has had a story where it’s had inflows and a lot of interest over the years. Is this way to do it, just pick the ETF?
Jeremy: I mean, you could buy a few of the companies. If you wanna speculate with Warren, you could get a few of them. They do trade on the ADR so you can get them here in the U.S. But I do think for a lot of people having the basket and abroad basket for a part of the international allocations, people have been underweight foreign markets. I think there’s a strong case, Japan is what is gonna do well coming out of this cyclical rebound, as you get a reopening, I think they are tied to global growth. And all the fiscal students around the world, I think, will be a boost for Japan, and DXJ would be a nice beneficiary of that.
Meb: What’s the composition look like? One of the things that people always needle me about when you’re talking about international countries is they have a slightly different sector composition, yadda, yadda. Is this a fund that ends up owning like 10 companies, does it own 100, does it own 1,000? What’s the general sort of landscape look like?
Jeremy: It’s about 440 companies, so it’s pretty broadly diversified. I sort of mentioned they’re leveraged to global growth. The 2 biggest sectors are industrials at 21% and then consumer discretionary, car company is at 20%. That is the most cyclical part, it does have… Tech is the next third biggest, around 15%. Financials have been growing in this sort of basket, it’s about 11%. Healthcare, 11%. I’m aware you get some of the strongest innovation coming out of Japan is healthcare. Jesper talks a lot about the local on the ground. Where is innovation happening? Japan is in the sort of forefront of some of the research services there. But it is a very cyclical global growth basket.
Jesper: Can I make one comment on sort of the general Japan side of things? Japan, if you look at it, of the 1,600 companies in the big index topic, there’s actually now almost 15% of them are trading at new historic highs. So they’re actually trading above where they traded at the peak of the bubble economy. So there’s a lot of companies, and these are these industrial companies, like Daikin Corporation, for example, right, trading at a new historic high. They’re an air conditioner company, that’s what they do, they make air conditioning. They make the best air conditionings in the world and that’s a big growth industry as the Asian middle class is gonna become more affluent, is going to put air conditionings into their place here.
So what I’m trying to say is Japan is excellent at keeping on doing the basics and getting the basics right. Japan suffers from the fact that it does not have a superstar. There is no Tesla, there is no PayPal in Japan. You ask me, give me a sexy technology name in Japan, of the big list of companies, I can’t put out a single name. There’s a lot of small and mid-cap stuff where you can have fun, where a lot of sexy innovation is happening. But for a global investor, you want the Sony, you want the Nintendo, you want the Tesla in order to get the attraction there. So Japan is for a calm, steady, compounded growth, not for the swift, “Oh, my god, it’s the sexy thing.”
Meb: That may start to sound good to people, after the last few days in the markets they could probably be pretty happy with that.
Jesper: It’s interesting. I talk to Japanese investors, they look at America and they say, “But they can’t believe this.” I mean, here’s Elon Musk, and he barely produces 400,000 cars, Toyota produces 10 million cars, think about that. And his capitalisation is bigger than that of Toyota. Now I can tell you, guaranteed in 10 years, in 50 years, in 100 years, trust me, Toyota will be around, I don’t know about Tesla.
Meb: Are there any other kind of bullet points parts of this thesis that we skipped over that we haven’t talked about today? I feel like we fit a lot of it. Anything come to mind.
Jesper: Just to chime in here. I mean, Jeremy obviously mentioned the replicating the Warren Buffett trade, you obviously go for the large caps. And there is a global cyclical recovery, they’re gonna be the big beneficiaries of that. I personally always will have a sweet spot for the small and mid-cap sector in Japan, because that’s really where the hidden Samurai are coming through. And Japan already did 120 IPOs this year, every single one of them trades at least 200% above the IPO issuance price. It tells you that once you go over the glip, and you dig one level deeper into the small and mid-cap universe in Japan, wow, there is money to be made.
Meb: That’s a pretty good batting average. I assume you guys have a whole suite of other Japanese exposures too, is that accurate?
Jeremy: So there’s DXJS is the currency hedge Japan. So just add the S, DXJS, and there’s an unhedged DXJA, which goes back to 2006, DXJS. The small-cap hedged one was launched a little later, but we have been hedging on hedge on small caps. Dividend-weighted, same kind of process, but for the small caps.
Jesper: Jerry, tell them what’s the dividend yield on the small-cap fund? I mean, this is the shocker.
Jeremy: Let me look that up.
Meb: By the way, that’s a pretty good batting average for the IPO stat. But it’s interesting when you talk about markets, you’re right, so much comes down to narrative and not having that sort of super charismatic, exciting, animal spirit sort of company. That’s not a trivial observation. I think that’s actually like probably pretty accurate in a world, where the Amazons, and the Facebooks, and the Tesla are in the headlines all the days.
Jesper: And you put yourself in my position, people always say, “My God, how can you be bullish on Japan? Because in 300 years, there’s only 11 people left, you’ve got this big demographic thing.” Now just because the demographics is going against you doesn’t mean that employment and the people’s purchasing power cannot grow. Number two, just because the demographics is negative, doesn’t mean that you can’t have globally super competitive corporations. So that’s sort of one of the narratives that you’re struggling with.
And then the other narrative, and this is where things may be changing, is that it was always “Oh, China is gonna overtake anything that Japan does sooner or later so I go direct to China rather than Japan.” And now, of course, with the frictions with the People’s Republic of China, Japan and, to some extent Korea, look much better because you say, “Hey, yeah, they actually do have a competitive edge.”
Jeremy: I could add the valuation stuff that he was talking about real quick. If you just contrast U.S. small caps with Japan, it’s sort of really interesting. You know, you think about the Russell 2000, 30% of it is now unprofitable, used to be 20% normally. During the pandemic, it’s rising up to 32% is not profitable. Almost nobody in the small caps you get much less dividends, they tend to be share issuers and negative buybacks, Meb, so the share issuance dilution. So you basically get a total shareholder yield of a half a percent is what I’m showing as of 7:30 for the Russell 2000 with sky-high PEs because so much of it it’s negative.
Japan, you’re basically getting, again, over 3% average dividend yield, they’re doing buybacks, they’re not doing share issuance, about 75 basis points on the net buybacks. Almost a 4% total shareholder yield there. PE is below 13 times and only 3% not profitable so, you know, versus 30 for the U.S. We also think of U.S. small caps, we think more volatility than large caps. In Japan, small caps are actually less volatile than the large caps tend to be more global growth-oriented. Small caps have been a little bit less volatile. So it’s sort of a different framework there.
Meb: If I was a little more thoughtful, instead of having this, listeners, you can’t see it. But if you’re watching this on the videos, Colorado background. I should have put some of my skiing from Asahidake, or Niseko, or running around Tokyo. One of my favourite times in Tokyo, it must have snowed, like, three feet, and just watching the carnage of one of my favourite cities in the world. My number one takeaway every time I come back from Japan is that every other culture in the entire world is barbaric compared to how you use the Japanese toilets.
I swear that I’m gonna get $1,000 TOTO toilet every time I come home and my wife is like, “We’re not spending it on that.” “You do not understand how much better this is.” And we actually don’t have like electrical in my bathroom, otherwise, they’d be throughout the house. Jesper, if we came over to visit, let’s say we gotta go on a holiday outside of Tokyo, where would you take us? Pretend I’m a first-timer, where would we go?
Jesper: I mean, obviously you wanna spend three or four days in Tokyo sort of doing the blade runner, you know, doing the weird futures stuff. Then you do wanna get down to Kyoto, the old imperial city for real-time travel. And then I would actually take you down to Naoshima, which is an old island that was bought by an eccentric entrepreneur and turned into an art island. And it’s got some of the best James Turells out there. And the whole atmosphere of this little island in the middle of the Inland Sea is just absolutely pristine and absolutely gorgeous.
And then last but not least, we get on a plane and fly down to Okinawa. And you will find that in Okinawa, actually, and this is true, the reef in parts of Okinawa has greater biodiversity than any other place on Earth. So you like skiing, I get that, that’s up in the winter. But Okinawa down south, absolutely spectacular holiday there.
Meb: Some of the pictures I’ve seen from Okinawa are just absolutely gorgeous. Some of the beaches look just absolutely stunning. So we’ll take you up on that when the world reopens. By the way, what’s the background story on your art behind you?
Jesper: Oh, that’s a friend of mine, Doug Bridge from Hawaii Island in Hawaii. And when the pandemic broke out, I didn’t ask him for it he just…that was just one of the things. Hello, beautiful women calling Earth. That’s a nice background to have.
Meb: It might be my favourite one so far. Gentlemen, this was an awesome first episode for us. I’m excited to keep these going because I think it was great. Where do people go…we’ll link to a lot of this in the show notes, of course, but they wanna find out more about sort of the Japanese thesis and the funds, where’s the best spot?
Jeremy: Wisdomtree.com, we’ve got a blog that Jesper contributes too, so you get thoughts from Jesper. Our blog, we have a fund comparison tool, you know, some of these stats that I was talking about, if you go to the website. Any mutual fund ETF, even some single stocks, you get sort of these kind of stats, the baskets on this, the valuations you get on the baskets and returns that you get on individual stocks. But the fund comparison tool would be very useful to compare any different funds you wanna look at on all these different metrics.
Meb: That is a great tool, I’ve used that over the years. And, listeners, if you think for some reason that WisdomTree is biased you can also go type it into Morningstar, and it’ll tell you the same thing. And it’s often shocking to me, at least, how some of those numbers tend to be a pretty stark spread, particularly with a lot of the U.S.-based funds. Gentlemen, it was a blast. We’ll have to do this again sometime. Thanks so much for joining today.
Jeremy: Thank you. This was great.
Jesper: All right. Sayonara.
Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us firstname.lastname@example.org. We love to read the reviews. Please review us on iTunes and subscribe to the show anywhere good podcasts are found. My current favourite is Breaker. Thanks for listening, friends, and good investing.