It was yet another volatile month whether it be financial markets or geopolitical/national news. I’m guessing many people have forgotten about the unprecedented Venezuelan intervention by US forces and the capture of former President Nicolas Maduro, to be eclipsed by Greenland and now Iran. But I’m sure we all continue to feel some of the after-effects whether they are a direct result of this action (such as oil prices) or adding fuel to a trend (weakening dollar, strong precious metals). I wrote about a year ago about the previously unfathomable possibility of the unravelling of the Western alliance and the bedrock of the global order. It frightens me that this appears to be closer to reality, especially after Mark Carney’s Davos speech. While our overwhelming popular PM has arguably placed Japan in pole position with regards to US international relations, I also worry that we may be placing all of our eggs in one basket, namely as it pertains to US-China tensions. On that note, I certainly don’t expect her to be a coordinator for the “G6 ex US” nor materially improve relations with Russia as some have called for. Like other nations, she’s focused on cost-of-living (in our case, persistently high inflation and a temporary consumption tax reprieve on food), immigration, and security/defense, as well as the March summit with President Trump.
 
Of course, that was the big event in Japan – the snap elections and her sweep with an unexpected super-majority, which means, if she wants to, that she can push through any legislation, including finally revising our Constitution particularly as it pertains to Article 9 Self-Defense Forces, a long-standing goal of former Prime Minister Abe. While it may seem like she was odds-on favorite from the start, our ever-liberal media had only put her in a definitive lead after exit polls during the early voting period; admittedly, it was somewhat satisfying to watch the shell-shocked traditional news media the day after elections. While I personally believe this is the best path for Japan and a stable political environment is always preferred (something rare in post-80s bubble Japan), the implications for Japanese equities is not as straight-forward whether it be inflation expectations and real wages, debt burden, interest rate path, FX, and, of course, Japan-China relations.
 
The market, so far, is focusing on the positives. As such, Japan was, again, the best performing equity market in January among the G7 countries (MSCI country indices, local currency), continuing the trend from 25Q4. But one thing Japan is not, is the cheapest. According to Bloomberg, the European countries in the G7 (UK, Germany, France, and Italy) are all cheaper on a forward PER basis. Japan’s PBR is the 2nd lowest but we also generate the lowest ROEs. Across all 22 MSCI developed markets, Japan stands at #14 in terms of low PER. It does have the 4th lowest PBR but also the 4th lowest ROE. Of course, the MSCI indices lean toward the large caps, but comparing the Topix 100, Topix Mid 400, and Topix Small, the forward PER is 17.2x, 16.9x, and 15.5x respectively so the spread isn’t as wide as I remember it to be.
 
With regards to our performance this month, there were very little single stock events and, as such, our highly concentrated flagship portfolio (<15 names) which has relatively low turnover is subject to the whims of the market. And what was very clear is that the continued outperformance of our tech hardware names was offset by significant underperformance of our tech software/SaaS names which include some that have little risk of marginalization by AI and, if anything, would be a beneficiary due to data moats. The same could be said about our diversified portfolio (~40 names) which has largely the same exposures, but the weight differentials and the lower idiosyncratic exposure due to the diversification effect (and thus higher factor exposure) was, in this short-term case, a positive driver which led to its outperformance, though I would caution that the reverse can easily be true in a weak market environment.
 
Each month seems to bring even more global uncertainty. I certainly cannot preempt what will occur in the short run and do not construct the portfolio with such views. But we maintain our long-term themes based on a Japan whose nominal growth is no longer zero, but neither is its nominal interest rates. Amazingly, our 30yr long bond yield is currently running at 3.5%! While the spreads between shorter durations is wider, I never thought I’d see the day that one could earn similar rates in Japan as other countries. There have been many surprises in post-COVID Japan, and I suspect there’ll be more surprises in the years to come.

Masaki Gotoh​​​

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“Pater ipse colendi haud facilem esse viam voluit. He that wrestles with us strengthens our nerves and sharpens our skill. Our antagonist is our helper.” – From Reflections on the Revolution in France by Edmund Burke, British politician and the founder of liberal conservatism.

 

On a random weekend flicking through TikTok, I came across a scene from The Day of the Jackal British TV series. I hadn’t realized there was a TV remake, but I was a huge fan of Fredrick Forsyth’s novels and had read most of his earlier works back in junior high school. But The Day of the Jackal was, by far, my favorite because it felt so real, particularly since the opening sequence is based on historical fact of the assassination attempt on President Charles de Gaulle. I, of course, watched the 1973 movie adaptation which was surprisingly good as well as the horrific Hollywood remake in 1997 called The Jackal (all great actors but terrible characters; why was Richard Gere’s character necessary?)
 
And so, particularly as the reviews were positive (and I really liked the TikTok clip), I had to watch this TV series. I got about halfway through season 1 but stopped. While I liked many of the scenes of the new Jackal, I found it to have the same basic problem as the Hollywood remake; the Jackal felt “wrong”, but in different ways. Forsyth’s Jackal was a machine-like professional maintaining anonymity showing zero emotions and very meticulous preparation. Bruce Willis’s Jackal was a more flamboyant Die Hard action hero (or, in this case, action villain) whose disguises couldn’t possibly be mistaken for anyone other than Bruce WIllis. The TV series was a methodical professional like the book, but he was also very human with lots of emotion. He was even married and had a child which I thought ruined the character. How could one maintain professional anonymity with a family??
 
In my view, the original stands out as the best. And it’s because of the villain. The antagonist is not just the helper but core to the story. I mentioned in the past that Goldfinger was my favorite 007 villain because of his coldness (“Do you expect me to talk?” “No, Mr. Bond, I expect you to die!”). But they were all great (OK, maybe not “all” but you’ll have to forgive my 007 biases). I think about great movies where we were rooting for the bad guy. The one that immediately comes to mind is Robert De Niro’s professional thief Neil McCauley in Heat. As much as we all loved Al Pacino’s character, who didn’t want McCauley to escape? And, of course, who can forget Heath Ledger’s Joker in The Dark Knight? Michael Caine said that Heath Ledger was so terrifying that he forgot his lines in his scene with the Joker. And as bad a person that Tony Montana was, we probably wanted Al Pacino’s drug dealer to survive in Scarface. Other possibly less well-known characters whom I’d suggest is Ed Harris’s portrayal of a rogue marine General Hummel in The Rock or the mentally unstable American-style “salaryman” William Foster played by Michael Douglas in Falling Down. Not all villains die or fail in the end, and we feel great satisfaction when they “win”. The obvious one is the perfect villain Verbal Kint/Keyser Soze played by Kevin Spacey in The Usual Suspects or his serial killer depiction in the shocking movie Se7en who didn’t even appear in the movie until about 90 minutes in. How about the spine-chilling Hannibal Lecter in The Silence of the Lambs? It’s hard to believe that Sir Anthony Hopkins only had 16 minutes screen time in the movie.
 
The common denominator about all these characters is that they are near-“flawless” in their own way. We admire that perfection. In real life, we’re all much too human to be that methodical and cold-blooded. In fact, it’s the human side that failed McCauley, Montana, and General Hummel. Often times, the antagonist exposes some type of hypocrisy or uncomfortable truths of society which is often gratifying. They go against the “norm” which requires method. Even the chaotic Joker orchestrated a precise, sequential plan despite his consistent mockery of those that follow a plan. The antagonists truly believe in their cause or goal, whether it be justice, ideology, or simply to make money. And because these villains were trying to make money illegally, they obviously have to be highly disciplined and methodical in order to avoid capture. They can’t afford to make a single mistake or at least, like the Jackal, have several perfect backup plans, preempting unforeseen risks.
 
Thankfully, investing is not quite as fatal. Besides, when it comes to fundamental investing, the human element is valuable, unlike criminal enterprises which, according to the movies, is a liability. Still, while we don’t have to be perfect, we have to be more right than wrong, or we go out of business. But I think that’s why I inherently like reversals vs momentum (in the short run; please see the last monthly for my definition of time horizons). It feels more difficult since you have to go against the norm and, unless you’re also a perfect timer, you have to suffer some period of discomfort as you go against the grain. But the reward also feels bigger. I remember thinking, back in my long-short days, that making 10% on a short felt 3x more satisfying than making 10% on a long, but it took 3x more work. As you might suspect, I have immense respect for dedicated short sellers (but would hate to have their job, no matter how profitable). While the anguish is not quite as severe as holding on to shorts, I do believe that one must have much higher conviction and will power with a reversal strategy vs momentum if one wishes to succeed. And the reward is greater if you can build conviction, lean into it, and ride it longer (assuming you are ultimately right, of course).
 
There’s always some sort of reversal angle I think about whether it be single stocks or themes. For example, I continually think about when we might synthetically add exposure to Europe or China (in terms of revenues by Japanese firms generated in those regions). Outside of tech, what (direct) sales exposure we do have in our portfolios outside of Japan is largely via SE Asia. But each time, I conclude that I’m hardly an expert of either region nor could I ever be from where I sit, so I’d rather be late than early. Besides, it’s not as if I need that exposure, but it would widen my current universe if I didn’t have to actively avoid them.
 
More recently, I’ve been thinking about AI disruption. While software/SaaS stocks have been underperforming from last year on a relative basis, it has become more acute on an absolute basis from this year due to agentic AI tools that could potentially automate entire workflows. It explains why we’re seeing more opportunities in this space from a valuation perspective. And I have no doubt that many such businesses will become obsolete. But right now, it feels like “shoot first and ask questions later”. It seems a little extreme as one could say that AI will replace any service or even the production of goods and it feels like we’re starting to price in an Armageddon scenario. Matt Levine of Bloomberg summarizes the sentiment well in his most recent article “The AI Whateverpocalypse Trade”:
 
“1. Right now, there is an economy. People spend trillions of dollars on goods and services, and many of those trillions of dollars go to big public companies as revenue.”
“2. In N years, AI will satisfy all human needs and desires, so people will not spend any more money on goods or services, and all of those companies’ revenues will go to zero. …”
 
Maybe. But if all company revenues go to zero, I wonder how we have any money to spend on anything. In either case, the markets are starting with certain sectors and going down the list of business models that will perish with hardware being the last, but I suppose a bunch of Terminators could start developing their own AI chips and equipment at some point too. But we are assuming that the path is inevitable, and we have started asking what the N years is for which industry. Perhaps AI adoption is much faster in the US, so N is fairly small. But SaaS maturity in Japan is far behind that of the US. And I do believe that there are structural and cultural buffers that will slow AI penetration in Japan. So N is, in my view, probably much bigger in Japan. Remember, most banks, government agencies, and schools still accept and use fax machines, so we have a long way to go before humans are “taken out of the loop” (a reference from WarGames).
 
But obviously, these buffers will not eliminate the AI threat, thus possibly validating the falling valuations. However, a software/SaaS business that was achieving double-digit top-line growth rates last quarter will probably not see 0% growth rates next quarter much less negative growth. Furthermore, most Japanese software/SaaS businesses are still AI adopters to achieve greater labor and technology optimization themselves versus their existing and potential customers who are, for example, still trying to evaluate whether they want to replace on-premises systems to a SaaS model. Should top-line growth rates of these businesses fall from eventual AI disruption, I would expect a period of time where profitability expands even further due to these optimizations. And given their extremely high ROIC, they have the capability to invest heavily in AI, probably more strategically than their clients.
 
But even assuming the worst, I tried one such exercise. For our worst performing company year-to-date, a media platform that arguably is a model case for high-risk AI replacement (I won’t go through why this is unlikely to be the case for this business), I computed how many years of constant growth rate decline would be required for the current valuations to be justified. The answer was 5 years. So the market is estimating that this company, whose top-line growth accelerated from +10% 2 years ago to +17% last year to over +20% this fiscal year, will see growth rates linearly fall to 0% with flat margins in 5 years. And I won’t delve into why margins will most certainly not be flat, though I use that simplification for illustration purposes. By the way, I’m using an 8% cost of capital translating into a 12~13x earnings multiple and ignoring the 10% of net cash they hold.
 
It’s still our third smallest position in the flagship fund so I still have to be more methodical before I can gain the conviction like our antagonists to raise our weighting to an average position or higher. But the human element in me feels that the odds favor being antagonistic toward the market trend. I suspect there are many other similar opportunities, especially in Japan.
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