playing the Japanese stock market today is harder than it seems

how so?

No, it isn’t the frequent market holidays.

It isn’t the semi-visible, semi-not, zaibatsu/keiretsu business links that tie firms together with amazingly strong (to me, anyway) emotional bonds that foreigners find difficult to assess.

It isn’t the fact that for many Japanese company managements–to say nothing of institutional investors–one foot remains in the samurai world.

None of this helps a foreign investor.  But learning a market’s quirks is arguably part of the price of entry a newbie pays everywhere he goes.

the market structure…

No, the biggest problem for a foreigner today is the structure of the market–the selection of stocks available on the Tokyo Exchange.  Despite the fact that Japan is a wealthy nation and the second-largest advanced economy in the world, its market is dominated by the export-oriented manufacturers, plus the suppliers and distributors that support them, whose heyday (ex the autos) was thirty years ago.

…makes Japan look like an emerging country

The market structure is more like what you’d expect from China or India.  It’s also a little like the US circa 1980.  In the US since then, however, junk bond and private equity barons have taken many older, low growth firms private.  Conglomerates have broken up, or spun off their more glamorous parts, in strategies calculated to maximize their value.  Venture capital has brought a host of new firms into the public arena.  Not so Japan.  There are counterculture exceptions:  Uniqlo and the social networking firms come to mind.  But still…

None of this is exactly news.  But it’s the genesis of the dilemma foreigners now face in the Japanese stock market.

today’s problem:  a weakening yen

Newly initiated quantitative easing in Japan is weakening the yen.  That’s making life more difficult for domestic firms that use imported materials.  And it’s also a lifeline for exporters, who use yen-denominated inputs and sell their products abroad.  So Japanese institutions have been selling the former to buy the latter.  Again, no surprise.  It’s what they always do.

The issue for a foreigner is this:

Ex the autos, the exporters are not a particularly attractive picture.  Historically, they’re a pretty sorry lot in terms of making money.  They face intensifying competition from lower-cost rivals in emerging economies.  By and large, managements are hide-bound and unable to commercialize higher tech products they have.  Law and custom defend dysfunctional incumbents against any shareholder attempts at change .  (Think:  Olympus …or Sharp  …or Pioneer  …or Sanyo   …or Casio   …or Sony).

In addition, for a dollar-oriented investor, at least a part–and probably most–of any yen-denominated gains will be offset by currency losses.  Although my general rule is not to get involved in forex hedging, this is an exception.  Whether you like or not, you probably won’t make much money on your Japanese stocks unless you sell the yen.

…which brings up another potential worry.  Exporters usually run substantial currency hedging operations.  In my experience, they’re pretty good at it.  Nevertheless, it’s always possible that exporters have zigged when they should have zagged.

my bottom line

For a long time, I’ve regarded Japan as a special situations market.  Find an outstanding company; buy and hold.  Enduring the current flight from quality is just a cost of doing business.  I have no desire to chase export-oriented names, although while the yen is softening I think exporters will continue to be market stars.  If I were managing dedicated Japanese money, however, I’m sure I’d find myself under performance pressure to do just that.

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