We have started the year with an underperformance. However, given that none of our names had announced December quarter earnings, no significant news flow was announced and monthly volumes of our portfolio companies were fairly normal, I’d say it was largely factor/industry drivers. While there was very little size or style bias, there was significant sector dispersion with the only sector groups in positive territory being Real Estate, Financials, “Communication Services” (whose top 2 names that account for nearly half of the index are Nintendo and Softbank Group [not the carrier] at time of writing), and Information Technology, most of whose constituents had also not announced December quarter earnings as of Jan end, but where our portfolio lacks exposure. All other sector groups were negative.
 
As such, while it’s never fun to underperform, this month doesn’t bother me much. I still like how we’re positioned especially given the increasing uncertainty with the near-term future of global trade. In terms of revenue at our portfolio companies (on a portfolio-weighted average basis), only 1% is generated from the US and 3% from China while over 80% is domestic. Admittedly, that domestic tilt is definitely on the high end for our portfolio, but we have purposely added to it given this uncertainty. Now I have no doubt that any weakness in the US or the global economy will also slow Japan’s domestic businesses as well as its exporters; no one will be truly isolated. But I continue to believe that Japan will be relatively shielded due to its own transformations, notably from rising interest rates and real wages. All of the recent economic indicators point toward similar outcomes. For example, the most recent household spending figures rose +2.7% YoY vs expectations of +0.5%. Retail sales figures show similar signs. Employment remains very tight and monthly labor cash earnings hit a new 28-year high. The spring wage negotiations are expected to exceed last year’s hikes which, itself, was the highest level seen in the last 30 years. Adding to this is with each higher-than-expected inflation figures, the BOJ sounds more and more hawkish. My wish to see positive real interest rates as a working adult might come true sooner than I thought.
 
The one area that continues to be weak is production and housing starts, the former due to the post-pandemic order rush and the subsequent reduction of inventory as orders slowed, while the latter is due to labor shortages and cost inflation causing prices to approach post-bubble highs in some areas. While production figures appear to have hit a floor, the recovery is still uncertain (and likely more linked to what happens with the rest of the world). Housing remains negative but the gamma has turned positive.
 
Of course, all of these figures are notoriously volatile and backward-looking (the releases themselves are data points from 1~2 months ago). Still, these trends have been continuing throughout 2024. When we speak to our portfolio companies (and their competitors and customers), while there appears to be caution with regards to aggressive price increases, they concede that wages will continue to rise in order to remain competitive and $-based costs will have to rise with the FX market where it is. “Labor productivity” and “IT/AI investment” are the new (?) buzzwords.
 
And, so, despite the uncertainties of global trade and the world order, I remain optimistic about Japan. While slowing global trade will have temporary repercussions, I believe the long-term trend that we had been discussing for the last 2 years will not reverse that easily.
 
Masaki Gotoh
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“Behave like a duck, stay calm on the surface but paddle like crazy underneath.” – Sir Michael Caine, English actor.

 

I briefly mentioned in my January 2021 monthly about a new word that my then-7-year-old son taught me (“discombobulated”). I’m ashamed to say this, but I have yet learned another new English word at the age of 52 – “mercurial”. I suspect you can guess in what context I read this (HINT for those like me who hadn’t heard the term before: it means “subject to sudden or unpredictable changes of mood or mind”).
 
I have to admit, “mercurial” can be used to describe myself at times. Now, I don’t think that I frequently change my mood or my mind, neither suddenly nor unpredictably. There is always a straightforward, logical sequence of thought processes that my mind is following to adjust my views; it’s just that I do it very quickly which others (notably my wife) may perceive as sudden or unpredictable. It’s not as if I have anger management issues, unlike a comedian I like very much, Bill Burr, whom I so frequently relate. There’s a bit from his Paper Tiger show where he goes: “She’s always just like, “Where did that come from? You just go from zero to 100 in two seconds.” It’s like, first of all, I idle at 75 miles an hour, so don’t give me this zero to 100.” I’ve had similar conversations with my wife a few times myself, albeit with less emotional intensity as compared to Bill Burr.
 
So, there are times that my mercurial nature has caused confusion, both at home and work. But there are benefits to this trait. While I suspect the news feeds are using the term in a disapproving manner, I learned that the term is not necessarily negative. It can also mean intelligent, enthusiastic, and quick. Now I don’t know about the intelligent part, but I am always enthusiastic and quick-minded. Nothing is too trivial, and I take every issue very seriously; it would be extremely rare when, if asked something, I just say “you go take care of it”. This is not due to a lack of trust but out of respect; if someone asks for an opinion, I will eagerly absorb that issue as if it were 100% my own and think about it carefully. The fact that I may respond extremely quickly does not mean that I’m impassionate about it or trying to minimize it. Conversely, if not asked, I presume that the strongly capable people around me are acting responsibility, whether at home or the office, and I only intervene when issues arise.
 
But having a quick and adaptable mind is, I believe, important in highly uncertain times like now. I’m consistently aware of the many moving parts in the world, though rarely reacting to each of them. I realize that many things could change between now and the future and we may have many opposing iterations in the interim. During my quants trading days or long-short days, I was perfectly capable of thinking about every tick on the tape when a corporate event is announced or making conclusions based on every word uttered by a policy official (or a political figure). I could easily flip a long to a short or double down on a position.
 
I am still capable of thinking this way but in a different light. I still think of the many possibilities, permutations, and probabilities, instinctively creating a real options model. The primary difference between my previous roles and now is that, back then, I would try to make an instantaneous buy or sell decision based on that theoretical options model and potentially take advantage of the price disruptions at that time. But now, I take those possibilities and extend it to months, quarters, or even years. What is the long-term effect of this event should it remain? Even if it does not, are there unintended long-term indications from, for example, a change in corporate mindset? How could the competitive dynamics change in either case, if at all? What would I do if I were sitting in the CEO chair? What would he or she, not being me, do, knowing that they think differently?
 
By extending the model to a longer time horizon, I can refrain from reacting to just the short-term implications which, particularly in this environment, can reverse very quickly. Ultimately, while it becomes an immensely complex mental exercise, it often leads to very little action, at least not immediately. This is partly due to the fact that, at present, we have chosen businesses that are less dependent on the macro environment, many that have idiosyncratic drivers or driven by Japan-specific themes. But also, it goes back to our core philosophy of choosing high quality businesses. While I would be the first to admit that we have never had a US president that could reverse decades of decisions and processes, whether right or wrong, I do believe that human nature which, in this case, I refer to the corporate leaders who need to think past the next 4 years, is not that simple or straightforward. I find it hard to believe that industry dynamics can be upended that easily to thwart a competitive advantage, though we do think about it constantly.
 
So, like the duck, we appear calm on the surface, but we are paddling like crazy underneath. Even when the waves become terribly volatile, we, the duck, may appear to simply be riding the waves, up and down like the broader index, and we will sometimes move a little forward and sometimes a little backward. But this is not from indifference but from a series of calculated choices that are constantly being updated, supported, and debunked. The fact that all we have done was adding +2% of exposure last month on existing names is not due to a lack of careful considerations, but, conversely, due to a lot of paddling.
 
And this is what makes investing so exciting for me. I hope we can share this excitement together as we continue our journey through the changing Japanese business environment.
 
PS: The above quote is often credited to Sir Michael Caine, yet another one of my favorite actors. But, in fact, the simile was originated in Japan although the creator is anonymous. The first known match was by a US columnist regarding diplomacy in Japan: “Duck diplomacy in Japan means that you float along placidly on the surface, but underneath you are paddling like the dickens with your feet.”​

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