Mon, 23 Jun 2014
Very attractive valuations compared to the U.S. market and an increased focus on shareholder value from Japanese companies combine to make Japanese equities attractive--but mind your yen exposure, says Dennis Stattman, manager of the Gold-rated BlackRock Global Allocation Fund.
Kevin McDevitt: Hi, I'm Kevin McDevitt from Morningstar. We're here at the Morningstar Investment Conference with Dennis Stattman. Dennis is the manager of Blackrock Global Allocation. Dennis, thanks for joining us.
Dennis Stattman: My pleasure.
McDevitt: So, right now in your portfolio you got about 18% or so in cash. I imagine part of that is concerned about rates rising in the future. If rates are to rise, what do you think will be the catalyst for that?
Stattman: We can never be sure exactly what will cause a change and just think about last year, Ben Bernanke made one speech and it wasn't a particularly hostile speech, and it triggered a massive sell-off in markets. So we're not so sure, but one thing to keep our eye on is inflation. Quietly the CPI and the core CPI have ground higher up to 2%, and they are rising. With Treasury bills yielding almost nothing and 10-year Treasuries at only about 2.6%, that's not a lot of margin to be paid for inflation risk or duration risk.
McDevitt: So if inflation is starting to pick up, what might be some ways that investors today might protect themselves and do so at decent valuations?
Stattman: We think the best opportunities in the markets are stocks, and depending on the area of the stock market, that might provide some inflation protection. As long as a stock is reasonably valued, has good earnings prospects and some ability to pass on price increases, it can be a hedge against inflation.
McDevitt: You mentioned Japanese equities as one of the areas you find attractive. Two questions for you there. One is, do you see the fiscal follow-through of reform to match the monetary stimulus. Also you mentioned in one of your notes that you are starting to see pension funds there starting to invest more. They've talked about investing more in equities. Given the track record of some pension funds, is that potentially a contrarian indicator for Japanese equities.
Stattman: Well, if it's a contrarian indicator for anything in the Japanese market, surely that must be fixed income, because they are chock-a-block full of it, and they're just talking about making a significant shift to equities. So they are far from all piled in.
McDevitt: So wait for the event.
Stattman: Well I wouldn't worry just yet about the contrary indicator. There's a lot to like in Japan, and it starts with valuations, which are very attractive compared to the U.S. market. The Japanese market rarely sells at a P/E ratio lower than the U.S. market, but in fact today the Topix index is at about 13.6 times earnings, compared to the S&P, which is at about 16.3 times earnings.
On a price-to-book value ratio, Japan is even cheaper, at 1.2 times book for the Topix versus 2.7 for the S&P, and price to sales--the Topix is at about one third the price-to-sales ratio of the S&P. And you have more conservative accounting in Japan. That's a lot of valuation support to like; those are powerful numbers. The story certainly doesn't stop there. As you mentioned, there is a very powerful monetary policy stimulus to asset prices in Japan. And the jury is out, as you note, on how many reforms we'll see from Abenomics. We're optimists on that. We're going to have to wait and see how much of those reforms come to pass, but we don't think that has to be the major support. We already have valuation and monetary policy, but it doesn't stop there. Japanese corporations are providing their own catalyst. They've become much more focused on shareholder value, and they're just getting started at unlocking shareholder value, compared to U.S. managements, which have been aggressively doing so for an entire generation. And we think that combination of companies that are putting cash back to shareholders in the forms of greater dividends and stock buybacks combined with great valuations and, by the way, good earnings gains, is a very powerful and dynamic combination in favor of the Japanese stock market.
Now I may hasten to say we're concerned about the yen. So we would suggest that investors who follow us into Japanese equities should hedge or at least partially hedge their yen exposure.
McDevitt: Dennis, thank you for your time.
Stattman: My pleasure.