Tuesday, February 28, 2012

Nomura Holdings: Japanese Equities To Outperform Japanese Bonds - Seeking Alpha

Marc Faber told us to buy Japanese equities last year, stating that government bonds in Japan would underperform equities. One of his stock picks was Nomura Holdings (NMR), which has a dividend of 2% and price to book ratio of 0.65. Its last quarter net earnings were $US 200 million, but it has experienced big losses in the previous quarters. Since Marc Faber disclosed his position in Nomura, the stock fell 20% to date. Nomura is a highly speculative play on Japanese equities, but I believe Japan is undervalued by investors.

I fully concur with Marc Faber to buy Japanese equities, and the best play for this is Nomura Holdings. If people start loving Japanese equities, Nomura will flourish as it is the primary brokerage service in Japan. Let's see why equities will outperform bonds.

Japanese 10 Year Government Bonds have been going up for 30 years and have recently started topping out. The 10 year government bond yield bottomed out at 1% (see chart 1).

While Japanese government bond yields will only return 1%, the dividend yield of Japanese equities has gone up to an average of 2.5% (see chart 2). This means that you will get a higher return in dividends when buying Japanese equities over Japanese government bonds. This cross-over happened somewhere around year 2007, where dividend yields crossed above bond yields. I strongly believe Japanese investors will switch their government bonds into Japanese equities.

One reason for this switch is the Japanese balance of trade (see chart 3) and Japanese current account (see chart 4). Since 2011 the Japanese balance of trade has been going significantly negative and the Japanese current account surplus has been going down. All this started to happen after the Fukushima disaster. As a consequence Japan will import more than it exports, which means more Japanese yen are going out of the country than money is flowing into the country. As these Japanese yen will be converted by foreigners into U.S. dollars, euros, gold etc..., the Japanese yen will diminish in value against other currencies. Recently, it was reported that the yen dropped to the lowest level against the U.S. dollar in 7 months.

This drop in the yen is felt by the Japanese consumer through inflation. The inflation rate is still extremely low in Japan (see chart 5). But when inflation starts to come in, the worst thing to have are Japanese government bonds, because the Japanese yen is losing its value. It isn't unthinkable that Japan will go into hyperinflation some day because of the huge government debt.

Considering that Japan has been deserted by fund managers, I think the best contrarian play would precisely be to buy Nomura Holdings at this time.

Disclosure: I am long NMR.

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