Hope you have been well. I know you don’t make investment decisions based on macro predictions but being an economist I was hoping to get your thoughts on something I have been pondering (and please correct me if I have something wrong).
I currently hold Zigexn, Nitto Kohki and Yodogawa Steelworks.
Of the three the most obvious undervaluation is Nitto Kohki due to cash on the balance sheet. This is my major concern with my investment. Japans inflation is currently 4.2%. Japans public debt to GDP is 263%. Obviously for a company holding high levels of cash inflation is bad.
From my limited understanding and 1,000ft view of the situation, Japan cannot raise interest rates sufficiently to combat inflation due to their high levels of debt. My thinking is yields will rise forcing Japan to either buy more bonds to suppress yields (weaking the yen and letting inflation run) or inevitably print more money to service the debt devaluing the currency (nowhere near to the same scale but similar to what Weimar Germany was forced to do to service war reparations).
The countries debt is the elephant in the room, I can’t quite get my head around. What is the path out of this for Japan?
Perhaps we have already seen much of the devaluation (at least in the near term) with the rest of the world raising rate and the Yen weakening. After all if major countries enter recession in the next year or two they will likely cut rates again strengthening the Yen, with the Yen also historically being a safe haven during the GFC, March 2020 etc. Increased inflation will also likely force companies to become better capital allocators.
Appreciate any thoughts you may have, but understand macro thoughts and predictions are often unknowable.
thanks for reaching out and hope all fine with you.
You're right. My stock investments are not based on macroeconomic forecasts. Mainly because I believe that the processes that determine macro outcomes are extremely complex and unpredictable (==> reflexivity).
Nevertheless, I will give you my view on your points made. Please take them with caution, because we enter a field that is dominated by many unknowns ==> ignorance.
Regarding the Weimar hyperinflation scenario. I consider this to be unlikely for Japan. Hyperinflations have not only a monetary component, but also a socio-economic/political one. Germany in the Weimar Republic was a deeply divided country/ society. For example, the struggle/ fights between the communists and the social democrats. And the (temporary) alliances of the social democrats with the reactionaries to put down communist/ spartacist uprisings. Also, the income inequality was extreme at that time. All not the case for Japan, and I do not expect them to become relevant in the foreseeable future.
Regarding Japan's debt.
The indebtedness of 266% to GDP is a Gross number. In my opinion, the net figure is more relevant. Here we are talking about about 160%. Still way too high, but significantly lower. More importantly, Japan is indebted internally, and a large part is held by (quasi) government institutions.
Also, Japan is the largest creditor nation. In short, Japan is not only highly indebted, but also incredibly rich, especially the private sector.
Nitto Kohki is an excellent example of this. A representative of corporate Japan, so to speak. All the (net) financial assets are the (partial) mirror image of Japan's public debt. Without the high public debt, there would be no high net cash position in corporate Japan.Ironically, the special investment case forJapan would have not materialized on an aggregate basis without the high public sector debt (and the negative sentiment that accompanies it).
Regarding Yen devaluation. The yen devaluation is already much more advanced than the nominal exchange rate indicates. Let's take the Yen/USD exchange rate. It hovered around 100 between 2000-2021. In that period, Japan had a reported deflation around -1--2%, and the U.S. inflation was roughly 2-3%, i.e. the yen has depreciated by about 4% (real) every year between 2000-2021. That is quite significant! And these are the official statistics. One could argue that the Japanese understated their deflation, and the U.S. their inflation. Then the (real) devaluation becomes even more significant.
There are many more points that I could make economically, such as inefficient tax system, etc., but it would go beyond the scope of a comment.
I am not saying that the Japanese do not have a problem! It is obvious that there are massive imbalances. But for which major industrialized country is that not the case?
In conclusion, I will leave the economic analysis and go into the sphere of creative imagination. The Japanese will one day sit down and say we have a "small" problem here that needs to be solved. And they will come up with solutions that will amaze us all. But I might be totally off the mark. I would have miscalculated the "real value" of their cash holdings, but still left with an investment in a decent operating business like Fukuda Denshi and Nitto kohki. IMHO that's what deep value investing all is about. An insurance against you ignorance!
I hope that my thought processes were at least to some extent helpful to you!
Thank you Otto, your thought process is extremely helpful and insightful! I appreciate you taking the time to reply, you have given me a lot to consider and dig further into. Keep up the good work with the blog, you have taught me and I’m sure many others a lot!
Interesting write-up, thanks for putting in the work!
I'm wondering though, if that historically high cash balance isn't actually more of a deterrent. I mean, in real terms that cash balance has significant negative returns and according to your write-up there are no plans to put this to work.
One comment mentions a new factory in 2025, but that's still at least 2 years of negative real returns. For a company with zero growth over a 10 year horizon.
Thanks very interesting. It looks like they will be building a new modern factory in 2025. This looks like it could be a material use of cash.
Thanks for contributing. Apreciated!
Great writeup! I'm leaning towards beauty, but the kind of beauty only deep value investors can appreciate. Thanks for bringing this to my radar.
Welcome
Hi O-Tone,
Hope you have been well. I know you don’t make investment decisions based on macro predictions but being an economist I was hoping to get your thoughts on something I have been pondering (and please correct me if I have something wrong).
I currently hold Zigexn, Nitto Kohki and Yodogawa Steelworks.
Of the three the most obvious undervaluation is Nitto Kohki due to cash on the balance sheet. This is my major concern with my investment. Japans inflation is currently 4.2%. Japans public debt to GDP is 263%. Obviously for a company holding high levels of cash inflation is bad.
From my limited understanding and 1,000ft view of the situation, Japan cannot raise interest rates sufficiently to combat inflation due to their high levels of debt. My thinking is yields will rise forcing Japan to either buy more bonds to suppress yields (weaking the yen and letting inflation run) or inevitably print more money to service the debt devaluing the currency (nowhere near to the same scale but similar to what Weimar Germany was forced to do to service war reparations).
The countries debt is the elephant in the room, I can’t quite get my head around. What is the path out of this for Japan?
Perhaps we have already seen much of the devaluation (at least in the near term) with the rest of the world raising rate and the Yen weakening. After all if major countries enter recession in the next year or two they will likely cut rates again strengthening the Yen, with the Yen also historically being a safe haven during the GFC, March 2020 etc. Increased inflation will also likely force companies to become better capital allocators.
Appreciate any thoughts you may have, but understand macro thoughts and predictions are often unknowable.
All the best,
Ryan
Hi Ryan,
thanks for reaching out and hope all fine with you.
You're right. My stock investments are not based on macroeconomic forecasts. Mainly because I believe that the processes that determine macro outcomes are extremely complex and unpredictable (==> reflexivity).
Nevertheless, I will give you my view on your points made. Please take them with caution, because we enter a field that is dominated by many unknowns ==> ignorance.
Regarding the Weimar hyperinflation scenario. I consider this to be unlikely for Japan. Hyperinflations have not only a monetary component, but also a socio-economic/political one. Germany in the Weimar Republic was a deeply divided country/ society. For example, the struggle/ fights between the communists and the social democrats. And the (temporary) alliances of the social democrats with the reactionaries to put down communist/ spartacist uprisings. Also, the income inequality was extreme at that time. All not the case for Japan, and I do not expect them to become relevant in the foreseeable future.
Regarding Japan's debt.
The indebtedness of 266% to GDP is a Gross number. In my opinion, the net figure is more relevant. Here we are talking about about 160%. Still way too high, but significantly lower. More importantly, Japan is indebted internally, and a large part is held by (quasi) government institutions.
Also, Japan is the largest creditor nation. In short, Japan is not only highly indebted, but also incredibly rich, especially the private sector.
Nitto Kohki is an excellent example of this. A representative of corporate Japan, so to speak. All the (net) financial assets are the (partial) mirror image of Japan's public debt. Without the high public debt, there would be no high net cash position in corporate Japan.Ironically, the special investment case forJapan would have not materialized on an aggregate basis without the high public sector debt (and the negative sentiment that accompanies it).
Regarding Yen devaluation. The yen devaluation is already much more advanced than the nominal exchange rate indicates. Let's take the Yen/USD exchange rate. It hovered around 100 between 2000-2021. In that period, Japan had a reported deflation around -1--2%, and the U.S. inflation was roughly 2-3%, i.e. the yen has depreciated by about 4% (real) every year between 2000-2021. That is quite significant! And these are the official statistics. One could argue that the Japanese understated their deflation, and the U.S. their inflation. Then the (real) devaluation becomes even more significant.
There are many more points that I could make economically, such as inefficient tax system, etc., but it would go beyond the scope of a comment.
I am not saying that the Japanese do not have a problem! It is obvious that there are massive imbalances. But for which major industrialized country is that not the case?
In conclusion, I will leave the economic analysis and go into the sphere of creative imagination. The Japanese will one day sit down and say we have a "small" problem here that needs to be solved. And they will come up with solutions that will amaze us all. But I might be totally off the mark. I would have miscalculated the "real value" of their cash holdings, but still left with an investment in a decent operating business like Fukuda Denshi and Nitto kohki. IMHO that's what deep value investing all is about. An insurance against you ignorance!
I hope that my thought processes were at least to some extent helpful to you!
All the best Otto
Thank you Otto, your thought process is extremely helpful and insightful! I appreciate you taking the time to reply, you have given me a lot to consider and dig further into. Keep up the good work with the blog, you have taught me and I’m sure many others a lot!
Thanks Ryan!
Interesting write-up, thanks for putting in the work!
I'm wondering though, if that historically high cash balance isn't actually more of a deterrent. I mean, in real terms that cash balance has significant negative returns and according to your write-up there are no plans to put this to work.
One comment mentions a new factory in 2025, but that's still at least 2 years of negative real returns. For a company with zero growth over a 10 year horizon.
Welcome!
Fair point! So a beast for you?!
I'm not sure. Certainly a solid company, but the big pile of cash makes me cautious. Watchlist for now, so somewhere between beauty and beast :-)
The twilight (-:
Thanks for the detailed analysis. The past shows that now might be a good time to start accumulating (business cycle-wise)
Frohe Neues im Voraus! :)
From your mouth to god's ears!
Dir auch eine schöne Weihnacht und guten Rutsch!