Sep 2023
September was a rather interesting month as is often the case. It is after the summer doldrums and the uneventful 1st quarter of the fiscal year (please see July monthly for details for more color). It was also post labor-day weekend when the Americans, who tend to drive flows in Japan (and, arguably, the rest of the world), come back to roll up their sleeves for the last leg of the year. So, what has been interesting for the last few months has been the slight divergence in returns. While the magnitudes were off, the broader markets were largely inline between both the US and Japan, notably in the large caps, until around July. Interestingly, small caps have significantly lagged and, according to the WSJ, has remained in a bear market since peaking in late 2021. This has been much more acute in the US than Japan, though I suspect the sub-book story driven by, whom I like to call “the world’s largest activist”, the Japan Stock Exchange, was a big reason for that divergence in the small cap space where the majority of sub-book companies used to rest in peace (using last calendar year end before the hype began, Topix 100 closed the year at a 1.24x PBR and 8.3% ROE, the Topix Mid 400 closed at a 1.07x PBR and 9.1% ROE, and Topix Small closed at a 0.90x PBR and 7.0% ROE). I provide some data below for reference. [Data and tables not included in this excerpt]
Please note that, in the table below, I include Nikkei 225 as I believe that is a closer proxy of international investor activity than the Topix 500 (Topix 100 + Topix Mid 400), but I believe Topix 500 is a fairer representation of large(r) cap performance (and is market cap weighted, unlike the Nikkei 225 which is price weighted), so I include both for your reference. I also show net value traded by investor type. “Trust banks” can be a proxy for domestic pension funds, “financials” are usually cross-shareholding unwinds so consistently negative, and “other institutions” is a mix of non-proprietary trading and, in recent years, driven mainly by corporate buybacks so generally positive.
From August and continuing into September, the trend seems to have changed slightly with the foreign-driven outperformance beginning to wane. Just looking at monthly returns, September returns may look benign, but the broader Topix index actually reached levels not seen since 1990 right after our insane real estate bubble had burst only to revert in full during the second half of the month (the Nikkei 225 reached its multi-decade high in June 2023 but failed to recover in September). Volumes, too, have been very high in Japan. The table below calculates average daily volume of shares traded in 2023 excluding SQ.
This might not seem significant, but there are only three times since the real estate bubble had fully burst that September volumes were the peak year-to-date. The first was in 2003 when we first began to recover from the IT bubble which had brought about the largest value amount of bankruptcies in post-war Japanese history, the second in 2005 when the Koizumi rally began in earnest, and the third time was this year. There were two other times that September reached close to peak year-to-date, once in 2019 after recovering from the mini-recession beginning in late 2018 and the second time in 2021 during the initial (and very premature) post-pandemic recovery. What is very different this year as compared to every other year where September volumes were so strong was that the markets were strong too. Market returns (using Topix but results with other indices are similar) were a decent +1.7% in Sep 2003, a whopping +11.1% in Sep 2005, a strong +5.0% in Sep 2019, and a nice 3.5% in Sep 2021. This September was -0.4% (and that was after renewing a 30+ year high mid-month).
I’m probably reading too much into it, but stocks “feel” weaker (and, of course, I’m biased since I’ve been saying all year that fundamentals and stock returns feel widely divergent). Needless to say, the fundamentals have not improved much. We’ll know more when the much-awaited mid fiscal year earnings season gets underway from late Oct ~ mid Nov. In the meantime, it seems that value has overtaken growth (although it had reversed in October-to-date). However, the all-important quality factor (the one that we care about the most) continues to underperform. In fact, the low PBR and low ROEs have been outperformers for the second month running, much to our conundrum, as our quality companies generally tend to trade well above book. But I do believe that as market uncertainty increases, this is where cash will gravitate. Until then, we will continue to wait it out.
Masaki Gotoh
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[The September 2023 monthly was regarding a specific stock in the portfolio that had detracted to performance during 2023 at the time of writing. Please contact me for further information if interested.]