Now is a good time to buy Japanese stocks over US stocks

published 24 May 2016

Ah, Japan.

If the Guinness Book of Records were ever to set up a division focused purely on financial and economic record-breaking, its head office would surely have to be in Tokyo.

A full 70% of Japanese government bonds trade at negative interest rates. In other words, if you buy and hold to maturity, you will make a loss in nominal terms.

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Now Goldman Sachs (who else?) has helped Japan's equivalent of the Financial Services Compensation Scheme to issue bonds at negative interest rates.

The mind boggles.

I'll delve a bit more into why investors might want to buy negative-rate bonds later in the week.

But for now, these negative rates have had an intriguing side effect that make me think that Japanese stocks could be overdue a healthy bounce

Japanese companies are piling into their own shares

Yet here's something interesting: Japanese companies themselves are filling their boots. They are currently buying back record numbers of shares. Already, roughly $36bn worth of share buybacks have been announced by companies listed in Tokyo. That's almost a full-year record and we're less than five months into the year, note Leo Lewis and Kana Inagaki in this morning's Financial Times.

Why are companies buying their own shares? After all, companies around the world are not well known for being good at market timing they more typically buy their own shares near the peak, not as stocks are getting cheaper.

Firstly, negative interest rates mean that companies don't want to sit on cash and effectively be fined for doing so. They'd rather spend their money on something else even their own shares.

Secondly, corporate governance reforms in Japan might be taking effect. These changes introduced as part of Shinzo Abe's grand plan to reinvigorate the Japanese economy are aimed at making Japanese companies pay more attention to shareholders' interests.

That involves many things being more answerable to shareholders, more open to activism and merger and acquisition activity, but perhaps most importantly, giving more money back to shareholders if there's no better use for it. Now, I'd prefer dividends to buybacks, to be honest, but share buybacks are another way to return money to shareholders.

Of course, share buybacks should all else being equal be good news for the stockmarket. Like everything else, if you decrease the supply of shares on the market, the price of the remaining shares should go up.

Indeed, share buybacks have arguably been one of the main drivers behind the US stockmarket's ever-climbing valuation over the last few years (more on that in a moment).

"Compared with the US", Nicholas Smith of CLSA tells the FT, "buybacks in Japan still represent a tiny proportion of market capitalisation." So there's plenty of room to go.

Buybacks in the US are drying up

Yet Goldman Sachs (again) reckons there's a potential problem here: "Corporate buybacks represent the single largest source of equity demand but may wane during coming months."

That seems to be happening, says Jon C Ogg on the 24/7 Wall Street blog. According to TrimTabs, share buyback announcements in the US from the start of the year to the end of last week amounted to $261.5bn. That's a lot. But it's also down about 35% on the same period in 2015.

This drop-off in a huge source of demand "does not augur well for US equities in the longer term."

This is just one reason I'd still favour Japanese stocksover US stocks. Another is that it's out of favour. According to the Bank of America Merrill Lynch fund manager survey, managers are more bearish on Japan than they have been since December 2012.

I've found this survey to be a pretty good sentiment indicator in the past the more everyone hates something, the better it tends to do in the longer run.

Finally, the Japanese central bank is under a lot of pressure to pull something out of the hat that actually works.

Rising buybacks, the promise of more money printing, and a market that's widely disliked? That's appealing to me.

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.