Japanese stocks are beginning to look cheap, according to Societe Generale Strategist Dylan Grice.
“There are those out there far smarter than me who thought the Japanese equity market was at bargain basement levels before the earthquake," Grice said. "And while I wasn’t sure I was in their camp a few weeks ago, as it has now come off the best part of 20 percent, the decision is now easier to make.”
Grice said he wasn't keen onJapanese stocks until now and this based on valuation grounds alone.
“It had nothing to do with any concerns I have over the government’s solvency," he said. "Without going through those arguments again here, I simply point out that a government default (inflationary or otherwise) is merely one possible scenario of several (and frankly, I hope it doesn’t happen)."
Grice said he believes there are a number of things the Japanese can do to avoid default, but questions whether the Japanese government will actually take them.
“What’s important is that at current prices across a range of derivatives, the risk can be hedged at attractive prices," he said. "And if we can hedge that tail, we’re free to focus on the more central part of the distribution. We can then consider boring old investment valuations with peace of mind”.
Lots of people have seen value in Tokyo before and been burned as the expected upside has failed to materialize, but this time it is different, he said.
“Valuations are beginning to look attractive," he added. "When you say to people that Japan is beginning to look cheap, a common reply is that it’s been cheap for ages. I disagree. Only in the past year or so has the Japanese equity market traded at a price broadly consistent with intrinsic value.”
Nuclear Questions Remain
The Japanese financial system is holding too many government bonds, but not enough equities and it could soon be time to buy with “both hands,” Grice said, adding he hopes that this is an opportunity that does not come to pass.
“Who knows how the current situation will play out? Something I’ve found striking watching the endless interviews with nuclear experts on the various TV news shows has been their confidence that there won’t, there can’t be another Chernobyl.” “The reactors and safety mechanisms aren’t even comparable, they say and I’m sure they’re correct," he said.
"I know even less about nuclear physics than I do about macroeconomics. But I do know that people mistake understanding the causes of a past event to understanding all possible causes of that event,” he said.
Grice said he worried that a Chernobyl type leak remains a possibility as a result. “Let’s hope and pray this doesn’t happen. But if it does, we could see another 20 percent off the Topix in very short order. At that point we should be buying with both hands.”