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International investors have shunned Japanese equities for years because of the ongoing troubles in the world’s third-largest economy. When the earthquake and tsunami hit in March, investors had yet another reason to stay away from the Japanese market.
Five months later it’s evident that fleeing from Japanese stocks after the disaster would have been a mistake. Of course, chaos is an investor’s worst enemy, and the horrific scale of death and destruction in Japan created confusion that appeared to defy analysis. But I think the most important thing long-term investors can do when facing acute uncertainty is to conduct business as usual, as strange as that may sound after such a terrible tragedy.
Immediately after the earthquake our Tokyo analysts kept cool under very difficult circumstances. They understood that the extreme shock would provoke extreme pessimism, and expected stock prices to plunge indiscriminately, with little regard for the companies’ long-term earnings potential.
As the scale of the damage became clearer, the key issue was when the auto and technology industries would be able to restore production. In the past two major earthquakes that hit Japan (in 1995 and 2007), fears of prolonged supply-chain disruptions were proven wrong. Companies worked together, sending engineering teams to fix the most crucial quake-damaged sites — the ones that produced the parts that were vital to opening the bottlenecks in key industries.
Based on this history, we believed that the damage to supply chains would probably be limited in duration, so we continued to focus on the long-term earnings power of Japanese companies. Some auto and technology stocks looked particularly attractive, especially those that appeared capable of restoring profitability after a short-term earnings decline. Such stocks started to pay off quickly as production came back. Share prices recovered from their postearthquake lows much faster than most investors had anticipated.
There’s still good value in the market. Japanese stocks are attractively valued compared with their own history and the global market today. On a price-to-book-value basis, Japanese equities were trading at a 39 percent discount to global stocks as of August 1. They also offered a 2 percent price-to-earnings discount to global stocks, after trading at a premium for four decades. That probably means that investors have lost faith in Japanese earnings power after the earthquake. In additiona, many worry about political instability and the future of nuclear power.
I think it’s wrong to give up on Japan. Since the earthquake many Japanese companies appear to be providing very conservative earnings guidance. Because production is coming back quickly, I wouldn’t be surprised if a flurry of Japanese companies beat estimates through the end of the year. With this in mind, I’m focusing on Japanese automakers and technology companies that don’t rely on the domestic economy for growth and trade at attractive valuations compared with their global peers.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio management teams.
Kevin Simms is global director of value research at AllianceBernstein.
