Biting the Bear Bullet : Steel-Eyed Investors Look to Japan’s Fallen Market

The Tokyo stock market--tumbling once again--is testing a precept that many U.S. investors have held dear since 1987: That the best time to buy any investment is when no one else wants it.

The issue, in Japan’s case, is whether it’s still too early to safely apply that rule, in the aftermath of one of the largest financial bubbles in history.

The Tokyo Stock Exchange’s Nikkei share index, which dove 647.66 points on Monday to 16,078.71, has given up 24% of its value since early September. To put that in perspective, an equivalent loss for the Dow Jones industrial average would be 900 points off the current level of 3,683.95.

On Tuesday, the Nikkei rebounded 327.83 points, and by midday today it had inched up another 277 points, to 16,684.37, as investors focused on talk of new government moves to restart the Japanese economy (and, by proxy, the market).

But neither Japanese nor most foreign investors appear to have much conviction that this recovery can hold. Unlike last spring, when many U.S. analysts were declaring that Tokyo’s prolonged bear market was finally dead, there is suddenly discussion of the Nikkei falling to 12,000--or even 8,000.

The deep gloom is somewhat peculiar. Between 1989 and 1992, the Nikkei plunged from its peak of 39,000 to 23,000, as rising interest rates, global recession and collapsing real estate prices slammed Japan hard. Since 1992, however, the index has bounced back strongly whenever it reached the 14,000 to 16,000 range.

Moreover, U.S. investors who bought Japanese stocks or stock funds early this year still are comfortably ahead, even with the market’s latest setback. Thanks to the yen’s strength against the dollar this year, the Tokyo market is up about 19% in dollar terms. That is three times the U.S. market’s gain, according to Morgan Stanley Capital International.

In other words, owning Japanese stocks has hardly been the worst thing you could do with your money in 1993. Indeed, U.S. investors, and other non-Japanese, have been credited with fueling much of the market’s strength this year.

Then why believe Japan is less of a “buy” now than it was at 16,000 on the Nikkei in January?

From foreign investors’ point of view, the problem seems to be a case of getting what you wished for--and then hating it.

For years, Japan has been criticized as operating a rigged stock market, one in which corporations and banks effectively conspired to keep share prices artificially high. Government policy, via low interest rates, protectionism and directed investment, aided and abetted the game. So did widespread political corruption.

Once the bubble of stock speculation burst, the West called for Japan to let its market, and economy, operate freely. With the end of the old political order last summer and the election of reformer Morihiro Hosokawa as prime minister, a “freer” Japan is exactly what was promised.

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And there’s the problem: What has crushed Japanese stocks in recent weeks is the increasing feeling that the new government won’t step in to prop up share prices, as the old government tried to do. “Hosokawa is letting the market find its own level,” says Christian Wignall, strategist at GT Global funds in San Francisco.

So with the Japanese economy still very weak, unemployment rising, consumer sentiment dashed and the strong yen still slashing export profits, investors have begun to focus on what Japanese stocks really are worth.

The classic measure of stock valuation is the price-to-earnings ratio, or stock price divided by annual earnings per share. Even with the dramatic plunge in Japanese stock prices since 1989, the Tokyo market’s infamously high P-Es have held up, because corporate earnings also have collapsed.

The result is that many Japanese stocks sell for about 40 times the current year’s estimated earnings. In contrast, American and European stocks sell for about half that.

If Japan is becoming less insular and more like the rest of the world, why should its stocks be worth twice as much? That’s where the ominous 8,000-Nikkei figure comes in. To really bring Japan down to Earth, the argument goes, you’d have to cut stock prices in half, so that Japanese P-Es matched those of the rest of the world.

Wignall, for one, doesn’t see 8,000 on the Nikkei, but he believes the growing perception of Japan as a state in crisis--and the real changes in the Japanese economy and political order--could trim the Nikkei down to 12,000 in short order.

Some U.S. investors, however, say this is once again time to buy Japan, not run from it.

Jamie Rosenwald, whose Rosenwald Capital Management in Redondo Beach invests $350 million globally, dismisses the contention that Japanese stocks remain far overvalued. Forget P-E ratios, he says, because accounting differences worldwide mean very different final earnings among American, European and Japanese firms.

The only fair way to compare stock prices, Rosenwald argues, is relative to the cash flow that companies generate before earnings, and relative to the assets underlying the stocks. On both counts, he says, Japanese stocks now look like bargains:

* Using Morgan Stanley figures, Rosenwald notes that the average Japanese stock now sells for about 8.4 times annual cash flow--cheaper than the U.S. market, at about 10 times cash flow.

* Measuring price-to-book value, or stock price compared to the per-share value of companies’ underlying assets, Japanese stocks sell for an average 1.8 times book, versus about 2.6 times for U.S. stocks, Rosenwald says.

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His conclusion: “It’s time to get on your big wading boots and get into the muck” of the Japanese market. If you believe in Asia’s economic potential in the 1990s, he says, Japan--as Asia’s primary financier--must win out as well. “You cannot have an Asian boom without Japan getting the benefit,” he says.

John Hickling, manager of the Fidelity Japan fund, also believes that the pessimism built into the Nikkei at 16,000 is far overdone.

It is true that the Japanese economy is in dismal shape, Hickling says. Hence, nobody seems to believe that corporate profits can reverse their four-year decline any time soon. Yet some Wall Streeters say it will only be a matter of time before the Hosokawa government takes serious steps to help the economy, even if direct intervention in the market remains taboo.

Even without new programs, look what’s happening, Hickling advises: Japanese interest rates are falling again, corporate cost-cutting is increasing in scope, and oil prices are tumbling.

“All of the factors that feed (Japanese) corporate profits are falling into place,” Hickling says. If you don’t believe it can happen, he says, just think back to October, 1990, in the United States--when the stock market bottomed even as investor gloom about the future reached epic proportions.

* STIMULUS PROMISED

Tokyo pledged emergency action to spark recovery. D2

The Nikkei Slides Again...

Tokyo stocks, in a bear market since 1989, have crumbled again in recent weeks to their lowest level since January. Analysts blame renewed pessimism about Japan’s economic outlook.

Tuesday: 16,406.54

Helped by the strong yen, U.S. investors have made money in Japanese stocks this year, even with the market’s latest slump.

Stock Market Gains, Year-to-date, Adjusted for Currency Changes Singapore: +35.3%

Germany: +25.0%

Japan: +18.9%

Spain: +18.0%

Britain: +10.9%

Canada: +10.4%

U.S.: +6.0% Source: Morgan Stanley Capital International

Assessing the Damage How some individual Japanese stocks trading in the U.S. have fared this year.

1993 Tues. Change Stock high/low close vs. high Sony Corp. 46 1/4-32 43 1/8 -7% Canon 71 1/8-53 1/2 63 1/4 -11% Matsushita 141 1/2-87 125 -12% Toyota 34 7/8-21 5/8 29 7/8 -14% Hitachi 84 3/4-55 1/2 70 1/8 -17% Mitsubishi Bank 29 1/4-17 1/2 23 3/4 -19% Honda Motor 31 3/8-19 7/8 25 1/8 -20% TDK 39-25 5/8 31 -21% Pioneer Elec. 27 1/8-17 1/8 21 1/4 -22% Kyocera 122 7/8-64 1/2 93 3/8 -24%

All trade on NYSE except Canon and Toyota (Nasdaq).