Sky-High Prices, Overrated Japan

An advisor submits:  Regarding Jeremy Grantham's apocalytic view, here's how I explain the current environment to clients.  Back in 2000, the investment landscape looked like the Alps, with stunning peaks (technology and some other large-cap growth) and deep valleys (REITs, small-cap value, energy, emerging markets).  Today, the investment landscape looks like the Tibetan Plateau, with high valuations in every direction, as far as the eye can see.

I had an interesting meeting recently with a portfolio manager for international equities.  When I asked him to describe a couple of recent portfolio additions, he said that he has been struggling to find anything new to buy at acceptable valuations.  He pointed to the run-up in value, the run-up in small caps, the run-up in emerging markets.  He noted that international markets were up 30% in the last 18 months in dollar terms, up 20% in local currency, and that "obviously" stocks aren't worth that much more now than they were then.

I then asked him how he justified his substantial overweight in energy stocks.  He has something like 22% of his portfolios in energy, vs. 7% for EAFE, and he acknowledged he would overweight even more except that the funds have a policy limiting sector overweights.  Hasn't energy had the same kind of run-up, I asked, as small-caps and emerging markets?

"Can you think of any other industry," he replied, "where prices have tripled?"  He said he assumes $50 oil, which he thinks is conservative, and even with that many energy stocks still appear to be much better values than anything else around.

I also asked him about his substantial underweight in Japan.  The explanation: He looks for high return on capital combined with low valuation -- shades of Joel Greenblatt -- and return on capital is pathetically low in Japan.

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Personally, I continue to have a hard time making sense of Japan as an investment opportunity.  Bulls emphasize that Japan is much cheaper than other developed markets on price/book and price/sales; bears emphasize that Japan is more expensive in P/E terms and that return on capital is awful.  In effect, bulls say, "You can buy assets cheap," while bears ask, "Why throw good capital after bad?"

Comments

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He pointed to the run-up in value, the run-up in small caps, the run-up in emerging markets.

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Hello friends!! Not only in “Japan” these high prices had been spread to all over the world. But compared to rest of countries prices in “Japan” are little more.

There are many reasons for this “Sky-High Prices” like “Recession”, natural calamities, and many more. The only things to reduce this “Sky-High Prices” are changes in politics, business and social effects…

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the japan markets are doing surprising well.

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After what happened in japan they still competitive and that's why i admired them. Thanks for sharing this, keep posting.

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