Our performance trend from the start of the year continued into July, both from a factor perspective as well as an idiosyncratic one. While I don’t mean to be dismissive about it, July is the least (fundamentally) important month in the least (fundamentally) important quarter, so I hadn’t expected much of a change to sentiment or trend this month. As I suspect many of you know, the majority of Japanese companies end their fiscal year in March. This is due to the fact that the public sector’s fiscal year ends in March and also matches the timing of most tax changes that go into effect from April as well as the new school year that also starts in April (so new graduates can start their new jobs at the same time right after graduating in March). There are a few exceptions. For example, retailers tend to close their books in February to avoid the peak Dec/Mar periods when inventory needs to be fully stocked while many firms with an international presence set their fiscal year end in December, similar to their clients and subsidiaries in the rest of the world.

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[Portfolio-related commentary regarding flagship portfolio as of Jul 2023 end]

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Still, as you can see in the table above, most listed companies close their books in March and is even more evident as you go up the size curve (interestingly, our portfolio is relatively balanced between March, June, and December). The reason the timing of the fiscal year end matters is that, unlike many other developed countries, Japanese companies provide full year guidance (and most also provide half-year guidance, which would be, usually, September end). This guidance sets the tone for the new year, both internally and externally. Are they upbeat or downbeat compared to their usual conservative or aggressive self?, And the “usual” is something that takes time to “feel” and could change when management changes although, when it does, it does so slowly. What are their expectations on supply and demand? If they provide half-year guidance, are the forecasts more front-half loaded or back-half loaded compared to normal seasonality? Not surprisingly, it’s generally back-half weighted but the question is about magnitudes vs normal years. This gives further visibility of conviction (or lack thereof). Once every 3 years or so, many companies also provide a separate mid-term plan, setting the tone for the next 3 years (which would have less to do with near-term trends but more about strategy and how we should expect management to allocate resources). As such, the period around the last week of April to mid-May is very intense for market participants and the companies. Similarly, the last week of October to mid-November is equally important.

 

As you would expect, it’s difficult to accurately predict your financials a year in advance. And because the full-year guidance is usually made around February or March, their forward 12-month forecasts are partially biased by what happened during the preceding 3 months, which includes the Christmas holidays, new calendar year start where expectations are often reset, and, more significantly in the last decade or so, the Chinese New Year. But a lot can change in 9 months and, as mentioned, their 12-month guidance is often back-half tilted. So, this is when we often get large revisions in both directions and why volatility and dispersion tend to be highest in November. The December quarter is also important since most international firms close in December, and, of course, you have the end-of-the-year holiday season. So many companies who were undecided as to whether to revise or not after the first half results will often do so after Dec quarter results (announced around early to mid-February). Personally, I think they should just do away with full year guidance and move to quarterly guidance, but companies complain that this becomes too short-term thinking which, arguably, is true. While, of course, we don’t try to game the quarters, the long-term is a culmination of sequential short-terms so it’s important to monitor them and understand how the numbers played out for signs of structural change, which may results in possible changes to risks and/or create opportunities.

 

For these reasons, the first fiscal quarter, being Apr~Jun, tends to be the quietest quarter for most companies as they train new employees and are just beginning to spend budgets on everything from R&D to procurement to advertising, which they often start somewhat slowly (all else equal) since it’s very hard to ask for additional funding mid-year. Factories are just starting up with rolling 3-month, 6-month, and 12-month production forecasts being released internally while they get the new workers up to speed. Yields, utilizations, and productivity are probably a little lower this quarter. And, because the new year just started, there tends to be a little less unpredictability. As such, Q1 results rarely sway much from the guidance provided just a few months ago (and why it is unusual to see any revisions to forecasts in Q1 except for exogenous shocks such as large movements in currencies or commodities or, of course, global turmoil, natural or otherwise). And because July is the IR blackout period before the Jun quarter results are released, corporate news flow tends to be particularly light in July.​

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Interestingly, we have a higher weight of June and December fiscal year end companies. This wasn’t out of choice, but it may be because we are more mid-/small-cap weighted. According to the National Tax Agency, including all unlisted companies, only 18% actually close their books in March, but if you look at companies whose common stock (which, by the way, is different from share capital or shareholder equity) is above 100 mln yen, the number rises to 52%. In either case, the June quarter is definitely more relevant to us. It keeps us a little more on edge than, I suspect, other market participants since 23% of our portfolio will be providing guidance for the new fiscal year, some of which may have new midterm plans, and another 30% have just completed their first half and might begin to revise their numbers. Still, it’s quiet from July to early-August. So, next month, I’m sure I’ll have much more to report. We are still part way into the quarter results season but, already, it feels a little more volatile than normal. We’ll see if that’s just a gust of wind or a change of the tides.

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I hope everyone has a pleasant summer and everyone can stay cool!

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Masaki Gotoh

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“Slow motion goes one of two ways. It either makes it look really, really cool, or it makes it look really, really bad.” – Blake Griffin, American professional basketball player.

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Japan feels like it has a lot of national holidays. According to Bloomberg’s Calendar function, there are 19 holidays, 5 of which happen to fall on weekends this year which is unusually high (i.e. only 14 observed holidays). Next year, only 2 fall on a weekend, so we’ll have a more normal 17 observed holidays and the year following will be 18 observed holidays. As a comparison, the US has 12 observed holidays, and the UK appears to have 9~10 banking holidays. The French and Germans are officially off for only 5 days this year and only 3 days last year! And while China feels like they have many more holidays than Japan, they’ve had 17~19 days off for the past few years according to Bloomberg which is not that different from Japan. I notice that many other Asian countries also have a good number of holidays, although not as high as Japan or China. I don’t know why Japan has so many national holidays, but my naïve reasoning is that the government wanted to force workers to take time off. For example, when I worked for a Japanese manufacturing company, I rarely used my paid vacation days except for sick days or a death in the family (no one in their right mind would ever think to celebrate, for example, a wedding on a weekday). And when I did take a day or two off, I’d usually come in on a weekend to make it back, at least to the maximum number of days that one can carry over the following year. In fact, I don’t think I ever used vacation days for “recreational” purposes. But no one actually said, “you can’t use vacation days”; it was just an unwritten rule. While that is certainly not true now (and probably illegal), and I may be stereotyping a bit, but I think many Gen-Xers (and, of course, baby boomers) probably took very few paid vacation days or, if they did, they certainly took their laptops with them. Shamefully, I came to work throughout most of the pandemic, and I probably check my emails more frequently than usual when I’m working from home or on holiday. It’s probably the fear of missing something important and feeling guilty about it. So, I’m thankful that there are many forced holidays, most of which, the government has been kind enough to place on Mondays or Fridays to make it a 3-day weekend. Of course, this also means that everyone is travelling at the same time, so flights, trains, and hotels are abominably expensive. It was even more so this year with the large influx of overseas travelers with their valuable US dollars in hand.

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Still, my family and I decided to take a trip to Hokkaido during the last 3-day weekend which was thanks to “Marine Day”. I have to admit, I have no idea what Marine Day is celebrating … fish, perhaps. We are an island nation so maybe that’s important … we have a Mountain Day too, probably because we are a mountainous, island nation as well as a Greenery Day because, well, we have lots of green? In either case, we take our nature seriously and celebrate it by making it a long weekend. I’ve only been to Hokkaido a few times for skiing, but I’ve always heard that it is absolutely lovely in the summer. And, putting aside our overpriced, cramped hotel that only had smoking rooms remaining, Hokkaido in the summer was exactly as they say it is – it was absolutely gorgeous! And the food was exquisite with wonderfully fresh ingredients, much better than what one can get in Tokyo (and much cheaper). We had a lot of time, so we decided to take a leisurely stroll to Hokkaido University, which, unsurprisingly, has the largest acreage in Japan at 660 sq km, larger than all 23 wards of Tokyo combined (the Sapporo campus is just a fraction of this, but still the 6th largest main campus in Japan at about 440 acres). My older son instantly loved it and said he wanted to attend this university after high school. I, too, thought it looked like a great place to study and reminded me of my own alma mater, Cornell University (whose similarly vast campus spans 745 acres). But I suspect what attracted us both is the city of Sapporo.

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Despite Sapporo being a very large city (the 4th largest population in Japan), its population density is fairly low at about 4,500 people per square mile. To put that in perspective, that’s less than, say, Denver, CO or Las Vegas, NV. The ward that I live in, Setagaya-ku, is ranked #13 in terms of population but has 9x the density of Sapporo, roughly the same as Brooklyn, NY (in fact, there are only 5 cities in the US that have a higher population density than where I live, Manhattan, NY, West New York, NJ, Union City, NJ, Guttenberg, NJ, and Hoboken, NJ). Needless to say, my son doesn’t like Tokyo very much. He really dislikes the huge crowds of people, all moving so quickly, and, from his young eyes, they seem unapproachably cold, unfriendly, and even rude (yes, I’m talking about Tokyo). Everything (in Tokyo) is expensive, every place is busy with a long wait, and there are no open spaces. But he really likes the countryside where the pace of life is much slower (with much more marine, mountains, and greenery), and the people seem much more soft-spoken and kinder. But he also has broader interests that an international city like Tokyo has to offer. Sapporo is probably a great mix of both (and, of course, it helps that my son loves snowboarding).

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I, like my wife, used to love Tokyo with its exciting night life, great international cuisines, and many people and cultures from across the country and around the world. I embraced the fast pace when I first moved to Tokyo after having come back from Cornell. Ithaca, NY, by the way, has a HIGHER population density than Sapporo (and Evanston, IL, where I went to business school, has 2x that of Sapporo). And, of course, having been working in the finance industry ever since business school, this pace of life grows on you (especially when that first finance job is Goldman Sachs). I woke up early, stayed out late, and filled my weekends with golf, parties, and extra work. But a lot changed as I, and my family, grew older. Life began to slow down, and the quiet periods felt more dear. And I, like my son, learned to love the country (my wife still prefers the city life which prevents us from moving, as well as the fact that there are few strong international schools outside of Tokyo). Going to cities like Sapporo does feel like life is moving in slow motion.

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My professional life in finance has followed a similar path. My early days of investing was in quants trading where I watched stocks move in ticks to days, then to long-short equity where I’d watch it in weeks to months (though I was frequently called upon during sharp intraday moves). Now, I analyze stocks in terms of quarters and years because fundamentals move in quarters and years. But I still closely follow the stock movements in terms of months, weeks, days, and even ticks … old habits die hard. But it becomes harder to reconcile fundamentals with such short-term movements. Of course, idiosyncratic company news such as earnings releases can drive ticks, but sentiment, perception, and conviction can change during the days, weeks, and months that follow. So it becomes a back-and-forth of watching short-term movements, trying to understand why a stock does what it does whether it be fundamental or technical (usually, a bit of both), resisting the urge to do anything immediate but keeping an eye on it and continually following updates to market sentiment or perception while gaining (or, on occasion, losing) conviction which may generate an action, and, at times, engaging with the company to potential create change which would generally take quarters or years to play out. It’s probably like living in Manhattan while trying to convince yourself that you are actually in Honolulu every night (which is probably why, as busy and stressful as these short 3-day weekends are, they are also very sweet).

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And I think to myself that the economy as a whole is much like this. I’ve become used to shock events in financial markets having experienced so many firsthand, many whose effects were fairly quick, or at least felt so at the time. This would include the Asian financial crisis of 1997 triggered by the Thai baht collapse, followed by LTCM in 1998 from the Russian default, the dotcom crash in 2000 from (arguably) rising in interest rates, the financial crisis of 2007~2008 (which was, with the benefit of 20-20 hindsight, a slow motion crash) which, itself, would ultimately lead to the great inflation and the fastest global interest rate hiking cycle in history triggered by the pandemic and the sudden global return to normalization, or at least its attempt to do so. And we’ll throw in there the 2013 Japan earthquake and the 2014 Russian financial crisis for good measure. Perhaps we are still living through a huge slow-motion financial cycle that actually started from the bursting of the first dotcom bubble. Or maybe it started even earlier, well before the Asian crisis. We have, of course, yet to see if the current rate cycle will lead to a global economic shock. Apparently, the market doesn’t think so anymore. But I don’t know … with rates rising from 0% to 5% in a span of 12 months, I can’t shake the feeling that the economy has still yet to adjust. As I mentioned above, companies can’t see 12 months ahead and why full year guidance is probably useless (at least as a forecasting tool; it’s still helpful to understand how management is prioritizing resources). I’m guessing that most people with debt obligations didn’t expect rates to rise +5% a year ago. And I’m sure there are those that are also benefiting from this too (such as anyone who borrowed at fixed rates during the pandemic). But I have to think that the velocity of money slows. If you think rates are going to fall, would one borrow now? If you think inflation will fall, would one buy now? Why wouldn’t you think about leaving your excess cash in a high yield saving account or brokered deposit? I believe that the economy moves in a much slower motion than the financial markets (and, more specifically, the equity markets) believe. Right now, this slow motion is making things look really, really cool and we are headed for a soft landing. For the sake of the world, I hope they are right.

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