The Nikkei stock index has a 55% chance of challenging the 38,957.44 HIGH in Dec '89!

Why it's still not too late to Earn from the Uptrend in Japan

June 18 2023 by KC Liew

The Nikkei has been on a tear in '23, up 31%, with 4,700 points(16%) of that move since May Day alone.  I  issued an alert for clients dated May 18th days after the index repenetrated the 30,000 resistance for the first time since Sep '21, postulating a 55% probability of it revisiting its all-time record of 38,957.44 points on the last trading day of 1989, over 33 years ago!

Back in March 2017, I was seized by a sudden urge to take a closer look at Japanese stocks, well before Warren Buffett set the current foreign buying frenzy of Tokyo stocks alight. I have been a student of arguably the largest equity bubble in human history for over two decades, when the above index rose from a recession low of 6,800 points in 1982 to a tad below 39,000 in the next 7 years. At that pinnacle, Japanese market capitalization comprised 40% of all world stocks combined & was handily larger than the US market & price earnings ratios soared to over 80 while dividend yields shrank to under 0.3%. 

Then, the overzealous Bank of Japan ruthlessly continued a raising of interest rates begun earlier that year, popped the gigantic bubble & exposed it for what it was: corporates & individual investors greedily borrowing cheaply to leverage land & stock purchases, each used as collateral for the other & vice versa, with banks complacently & equally greedily disbursing 100-300% of soaring land collateral values on the false assumption that property prices on the islands would never fall.

To cut a long story short, the unwinding & disorderly descent bankrupted individuals, speculators, many corporates and eventually even large banks as their collateral shrank with the 82% descent in the Nikkei over 20 years and an equally steep deflation of land prices. However, the companies which survived learned from that bitter experience & built up their balance sheet buffers even as their stock prices fell below book value & dividend yields rose to 3-9% after the 2008 Financial Crisis.

Going back to Mar 2017, I purchased books detailing the background of the Bubble Era of the 1980s & soaked up the history(including that of a female Osaka restauranteur who borrowed astronomical sums to amass a stock portfolio far larger than Buffett's at that time), as well as buying company handbooks that contained summaries of listed companies. In the years since, I have uncovered a treasure trove of online information, superbly translatable by Google & went about the arduous task of short-listing undervalued stocks by Benjamin Graham standards as well as studying their short- & long-term chart patterns. 

My first stock purchase was a somewhat random discovery & I excitedly bought 1,300 shares of Fujisash(5940) from ¥102-110 yen on July 4th 2017. A chance emerged within a week to dispose profitably at ¥122 but I got greedy, declined to sell & it eventually dropped to a low of  ¥92. I would go on to sell these at an average price above ¥173 in June 2018, getting lucky as I randomly discovered the price had gone 'limit up' the day before due to a common phenomenon called 'ramping'.

In the last months of '17, as the Nikkei rose to the highest levels since 1996, I got lucky with other stocks, including one 'contra' gain on Katsuragawa Electric[ bought  ¥1,550, sold  ¥2,100 three days later] & even a trade on famous electronic brand Pioneer, selling near its Feb '18 peak just months before it became insolvent & was bought out at a huge 71% discount to my original entry price(Whew! A close call, that one!!) 

Yes, I did pick a couple of losers as well, yet surprisingly, my accuracy rate has been far higher in Japan than locally, with a practice of studying as much as I can dig up on a particular company before purchasing it, using the balance sheet as a gauge of its undervaluation. Some picks paid off big many months of paper losses after my purchases, like Nishishiba, taken over by Toshiba for a 40% premium & Sekonic, bought out at a 166% surplus over my entry level almost 5 years later.

Recently, the Tokyo stock exchange(now called the Japan Exchange) pressured its members trading below book value to take measures to improve their performance & appeal to investors. How many are affected by this directive? Over 1,800 companies!!! No wonder this market attracted famed bargain hunter Buffett & other foreign fund managers!

The recent inexorable climb is due to several factors:

1. Corporate reform & measures to enhance shareholder value

2. The Bank of Japan(BoJ)'s refusal to follow other global central banks & keeping rates close to zero.

3. Improved corporate earnings with economic recovery post-Covid, with the P/E at 15 compared to a historical average of over 21. 

On the Nikkei chart is a clear, stair-stepping pattern upwards that is characteristic of a firm uptrend & after the latest penetration of 30,000, the double-top scenario from 2021 has been annulled & confidence is high among market movers that the index can rise a few thousand more points to revisit that legendary peak of the Bubble Era, the longest-ago peak of any equity market anywhere.

Right now, many stocks have barely budged as the index is being carried up by large cap companies, but if previous periods are any guide, these will eventually rise to narrow the valuation gap as dividend yields of 3-7% can still be found aplenty among the nearly two thousand companies being directed by the exchange to improve their performance.

The key is stock selection, with dividend yields, financial strength & widely competent Japanese management providing a credible safety net as long as the BoJ declines to raise the cost of borrowing. Local investors have been net sellers in this rally but they have traditionally been poor timers(buying in the late 1980s even as foreigners sold heavily five years before the bursting of the Bubble). The wall of foreign money has proven to be too huge, driving the index up despite fears of a recession in the US as the falling yen makes Japan cheaper & not merely boosts exports. 

My theory is that eventually, selling will slow the large cap, expensive stocks & the proceeds will move to mid- & small-cap Tokyo stocks, providing huge upside moves in many of these as was witnessed in the first stage of the 'Abenomics' bull market from 2012-2013.

I have perused the stock charts of over 300 companies(a process still ongoing!) & sifted out the ones that have stabilised at supports reinforced by multi-year(sometimes multi-decade) lows, with longtime major shareholders & aggressive share buybacks as plus points in my evaluation.

Pondering over the cycles of peaks & valleys in the Nikkei going back to the re-opening of the Japanese stockmarket in July 1950, I project the ultimate peak of the current cycle to occur in 2024 at the very soonest, giving short-term traders at least 5 months to play this trend while handing longer-term investors a great alternative for high dividend yields on stocks with limited downside in a reserve currency that is one of the few that is still cheap relative to the ringgit.

Alert originally posted on my blog(https://stocklaser.blogspot.com/) as well as my FB page.