Value Investing and the Vice of Being Fearful

When a negative trend has been sufficiently long-lasting the tendency of investors to extrapolate the past into the future becomes extremely pronounced.

At the beginning of a true bear market euphoria turns into fear. Later that fear, accompanied by despondency, turns into a negative bias concerning an asset class or an entire market. The negative bias than manifests itself in apathy and ignorance.

Never Mind The Nikkei?

The Nikkei 225 Stock Index is a perfect example. It peaked out at roughly 39,000 in 1989. Now, 26 years later, it sits at around 20'000. Over the last quarter of a century the Nikkei has lost nearly half of its value. From peak to trough the index lost a breathtaking 80%. The Nikkei hit rock bottom three times during the ferocious bear market. Always setting a low around 8'000 index points. Once in 2002/2003, than again 2008/2009 and the last time in 2011. Corporate Japan was on sale and nobody cared. Not even the so called value investing community was willing to wholeheartedly enter the market and load up the bandwagon with Japanese stocks. Granted, the valiant value investor does also exist in Japan. But it is rather a threatened species. 

With more and more experience investing in Japan, more and more it dawned me that very few value investors appear to be truly focusing on the safe and cheap criteria outlined by the great work of Graham and Dodd. Because, if they really were focusing on the concept of margin of safety, and not simply chasing performance, they would have nothing but valuable Japanese stocks in their portfolio. Investors in general have been perceiving Japan as risky. They have been perceiving corporate Japan as intransparent for an extended period of time. Granted, Japan was not, and very likely will not, playing after the rules of Anglo- Saxon shareholder capitalism. But is that enough of a reason to give the Japanese stock market such a ridiculous corporate governance discount? Especially when corporate Japan is obviously trying to change?

The same people that were not buying into Japan during the troughs are now claiming that the Japanese stock market, after the significant Abenomics run- up, is not cheap anymore. They appear to be oblivious of the fact that Japan went through the mother of all bear markets. I argue that the Japanese bear market in stocks was even more severe than that of the U.S of America during the 1930's. Maybe not in the severity of real declines of stock and house prices. And certainly not in the socio-economic implications. But it was more severe in its timely extension and in the apathy, agony and paralysis it evoked in investors.  Peter Tasker explains the phenomenon we are witnessing regards investing in Japan brilliantly by stating: "A real bear market is stocks crashing and staying crashed. A generation is wiped out and does not come back, an entire asset class is discredited. At some point, fundamentals improve, but nothing happens because no-one is there, no-one is watching."

History Does Not Repeat But It Does Rhyme

The Japanese bear market and recovery does not follow the text book of the crash that corporate America was going through in the 1930's. But it does rhyme. When Graham and Dodd wrote their seminal book Security Analysis nobody was interested in buying listed equities in the U.S. of America. Even 13 years later, when Benjamin Graham wrote the Intelligent Investors, you could hardly convince anyone that there was ample opportunity in the stock market. Going through the grinding economic torture of the Great Depression, and the period of lost hopes of the 1930s, the investing public was left despondent, apathetic and paralyzed. Needless to say that it was exactly that frame of mind that made the stock market in general, and individual shares especially, very attractive valuation wise for a long period to come.

Granted, from its secular lows the Nikkei has risen more than 120%. But is it not like with the S&P 500 between 1930 and 1960? 1942, the S&P 500 Index also had risen by over 120%. But the US stock market than, like the Japanese market today, remained attractive. Because stocks were still widely reviled. Between 1950 and 1960 the US stock market rose by another 250%.

Mind The Fear Mongers!

So why the negligence regarding investing in Japan when the overall market is attractively valued and segments of the market are outright cheap? Because the great majority of investors are paying way too much attention to incompetent fear mongers. Unfortunately, the fear mongers do not know about their incompetence and thus, often sound very convincing. In addition, propagating the message of fear and despondency appears to be much more powerful than that of hope and faith. Concerning Japan, now investors are being told they better be fearful of the advances the Index has made and of the prospect of the bull run ending abruptly and severely. In the past they were told to be fearful of Japan being on the brink of entering a full blown financial crisis.

I am convinced that a great deal of investors sense that at the time of extreme pessimism they have to part from the fearful crowd and their beloved money. When the Nikkei troughed I am sure that many value investors have felt the extraordinary opportunity lying in front of them. But they did not dare to buy. They did not trust their feeling. Because again they were told to be fearful. That Japan was different. Investors were eagerly picking up the story of doom and gloom about Japan, but not any Japanese stock. Now that the broad stock market in Japan has risen significantly investors start to regret. They are realizing that again the time to buy was not different than on so many other occasions in their investment career. But they are still not investing. They are even more paralyzed because fear is now accompanied by regret.

Hope, Faith And The Difficult Task of Being a True Contrarian Value Investor

Thomas J. Niedermeyer from Steel Partners once remarked: "I am strongly recommending that people do the courageous thing and invest in value in Japan at a time when people don’t want to hear about it. If you are truly an investor, and not simply chasing performance, you need to be brave. You need to do something different from what the herd is doing. It is not easy, but that’s what has made many good, disciplined investors rich in the past. Here is the bottom line: investor apathy on the Japanese market has never been higher, and stocks have never been cheaper. Now is the time to buy Japan."    

In a severe bear market you need to have hope and faith and not regret and fear as an investor. From own experience I know that it is not easy to part from the herd. And I am well aware that it is difficult not paying attention to fear mongers when markets have been crashing and staying crashed for an extended period of time. Investors apathy on the Japanese stock market used to be higher in the past. Nevertheless is it still elevated. The Japanese stock market in general is reasonably valued and many individual shares are outright cheap. The window of opportunity in the Japanese stock market is still wide open. Even after this huge run-up in the Japanese stock market in the last 2 1/2 years is Japan still a stock picker's paradise.

The business depression in Japan started in 1989, and extended to an all-time record of 24 years. Than Shinzo Abe entered the stage of this creepy spectacle. He was uttering a message of hope and faith. But the majority of business people and investors within and outside from Japan did not notice. They did not notice the message Shinzo Abe was bringing and they did not notice that the depression was fading into nothingness. They did not notice because they were so fearful and despondent and it was so dark. But than some staff in the theatre started to raise the illumination gradually. And the darkness slowly transmuted into light. And so did the spell of fear in the minds of the audience gradually faded away and turned first into hope and then into outright faith.


Source:

Investing in Japan: Only the 'cockroaches' survive by Hannah Smith

As Contrarian Investments Go by Tim Price

Steel Partners Japan; Letters to the partners; March 2008