Editor's Note: This article, by Alec Young, International Equity Strategist at Standard & Poor's, was originally published in the February 2010 edition of Capital IQ's Monthly Market Observations, pp. 34-36.
Japan is the largest overseas stock market in the world, recently weighing in at 14.6% of free float adjusted international equity market capitalization. Just when its long-term underperformance has led many investors to thoroughly dismiss it, Japan is finally outperforming. It’s the strongest major stock market in the world year-to-date by a wide margin, rising 9.3%.
Given its large benchmark weight, being underweight Japan when it outperforms risks detracting materially from performance. In addition, from a contrarian sentiment perspective, the mere fact that Japan has been relegated to perennial underweight status implies to us that it is due to post much more competitive returns. After years of underperformance, we believe everyone who would want to lighten exposure to Japan likely already has. Additional turnaround drivers we foresee are outlined below.
S&P Economics expects Japan's economy to expand within a range of 1% to 1.5% in 2010, up from 2009’s estimated 5.4% contraction. With domestic demand remaining weak amid deflationary pressure and political uncertainty, we believe a recovery is being driven by improving external demand. The consensus expects Japanese corporate profits to rebound sharply in 2010 as China and the U.S., Japan’s two largest export markets, continue to recover. Through November, these two markets accounted for 35% of Japan’s 2009 exports. Furthermore, Japan derives an additional 34.2% of its export revenue from other faster-growing Asian economies like South Korea, Singapore, Hong Kong and Vietnam.
Japanese export earnings should also benefit from a more stable yen. The country’s export EPS suffered in 2009 as the yen rose 9.5% vs. the U.S. dollar, making the country’s exports less competitive in the U.S., as well as in China and Hong Kong, both of whose currencies are pegged to the greenback. In order to maintain 2009’s torrid rate of appreciation, the ¥/$ exchange rate would have to average ¥84.7/$ this year, 6.7% above current levels of ¥90.8 /$, by our analysis.
As a result of improving Asian and U.S. demand, as well as easing year-over-year currency comparisons, the Japanese export recovery that began last March should continue to accelerate, by our analysis.
Lastly, while analyst EPS revision ratios in other foreign markets peaked in the fall, Japan’s continue to make new cyclical highs.
Also, Japan is trading at a historically cheap level, at 18.2X 2010 consensus EPS estimates, a 14% discount to its 10-year average of 21.2X forward EPS. We believe this increases the likelihood of more competitive returns in 2010.
Several ways to profit from this is by buying Japanese ETFs JOF, JEF and DJF.
Tuesday, February 23, 2010
Tuesday, February 02, 2010
Don't Buy REITs
If you feel like investing in real estate, you're better off buying cheap lots in Florida rather than REITs. Yes, it is possible to buy a waterfront lot for under $5,000 - a much better investment than the stock market right now. Check out this essay by Dan Amos:
The commercial real estate crisis may be the most anticipated crisis in history. But just because it's widely anticipated doesn't mean that the crisis won't be destructive for REIT shares. Since most REITs are richly valued, the slow-moving commercial real estate crisis will ensure that future returns disappoint.
Consider the valuation of REITs versus the S&P 500, which itself is overvalued. Despite being 25% below its late 2007 peak, the US stock market - measured by the S&P 500 index - is very expensive. The "Shiller P/E ratio," developed by Yale professor Robert Shiller, measures the S&P 500 against the average S&P 500 earnings over the previous 10 years, adjusted for inflation. It's a much more robust measure of valuation, considering the fluctuation of corporate earnings, and the fact that after bubbles, much of the earnings booked during the boom are written off during the bust. Consider that the earnings booked by Citigroup and other big banks near the peak of the bubble were largely written off during the bust. Therefore, a 10-year average of earnings is a better indicator of true earnings.
The Shiller P/E ratio for the S&P 500 Index is now 21 - up dramatically from 13 at the March 2009 lows. This 21 P/E is higher than at almost any point in stock market history, outside of the late 1920s bubble, the late 1990s bubble, and the market peak in 2007. The S&P 500 is overvalued based on the Shiller P/E, but corporate earnings are supposedly going to soar in 2010, right? Well, even if you believe the optimistic 2010 estimates, the market is still more than fully valued on that metric.
Ditto REITs.
Commercial real estate - and the REITs that hold commercial properties - began to deflate rapidly in late 2008. But the Fed stepped in with bailout funds and easy money to halt the deflation...and even pumped the bubble back up a bit. The nearby chart shows the results of the Fed's handwork. REITs of all shapes and sizes more than doubled off the stock market lows of last March, while the Bloomberg Hotel REIT Index more than tripled. (We'll come back to this chart a little later).
This rally has the look and feel of a dead-cat bounce, which means that it provides an attractive short-selling entry point.
REITs soared as the bubble inflated from 2000-2007, then crashed when the bubble popped in 2008 and early 2009, and then launched a dead cat bounce when the Fed flooded the system in mid-2009 with massive injections of liquidity and cheap credit. Now REITs are priced at bubble valuations - valuations that bear little resemblance to economic reality.
This bounce has postponed a healthy purge of assets in which old capital invested by foolish speculators during the bubble would have been wiped out - clearing the way for new owners to assume title to real estate at reasonable prices. When central banks prop up deflating bubbles with super-easy bailout cash, the bubble investors don't liquidate their overly inflated assets. They hang on and hope for a turnaround.
But bubbles always deflate...always. Government intervention merely muffles the hissing sound for a while. This story played out in the Japanese real estate bubble that peaked in 1990, and it's happening with the US commercial real estate bubble that peaked in 2007. Capital becomes trapped in a dead asset class, thereby stretching the bubble's resolution out over decades.
Toward the end of 2009, it became clear that "extend and pretend" had become the official policy at most banks that hold commercial mortgages. We won't see a cleansing flush of hundreds of billions in underwater properties changing hands to new owners. Instead, properties will be dribbled out of the foreclosure pipeline at a slow pace. This measured pace of foreclosures will add to the chronic glut of property that will be quickly listed for sale into any bounce in demand.
Some of the best short-selling opportunities in the REIT sector may be in the hotel REIT sub-sector.
It's not a stretch to expect the hotel business will be ugly for a long time. Corporate and leisure travel is in the midst of a depression. And leveraged hotel owners built or acquired too many hotels near the peak of the commercial real estate bubble.
Now many hotel owners are desperate to generate cash in order to pay down debt and retain titles to properties. Some are slashing nightly room rates below break-even levels. You know from the growth of Internet hotel booking services just how much more competitive and transparent hotel pricing has become over the past decade. Unless competitors are willing to match the pricing of the most desperate hotel owners, healthier competitors will suffer lower occupancy.
Some levered hotel owners, like Sunstone Hotel Investors, are abandoning their equity in some properties to salvage others. In the fourth quarter of 2009, Sunstone defaulted on several nonrecourse mortgages held against 13 of its properties and turned the title over to its lenders. Sunstone calls this a "deed-back," but it's really a strategic default.
Sunstone's lenders will probably keep and operate the hotels, rather than dump them at a distressed price. The behavior of Sunstone and its lenders shows how many hotel owners and lenders are putting off the necessary liquidation of underwater properties with bloated cost structures. The industry still needs to make more progress on downsizing, slashing operating costs, shrinking mortgage sizes, and lowering room rates to match demand. Until it does, the industry's returns on capital will not consistently exceed its cost of capital.
Hotel REITs are highly sensitive to perceptions about the near-term health of the hotel business. Trends in occupancy and room rates shape perceptions about earnings. Hotel REITs own portfolios of hotels and outsource the management to companies like Marriott for a fee.
Because of the relatively fixed costs of paying management companies a fee for operating hotels, Hotel REITs operate with high operating leverage: A 20-30% decline in revenues can translate into a 50-75% decline in operating income. Also, unlike offices or retail REITs with sticky long-term leases, the cash flow for hotel REITs adjusts quickly to changing conditions on a day-by-day basis.
Over the past nine months, hotel REITs have soared on the perception that corporate and leisure travel will rebound strongly in 2010 and 2011. Analysts have forecast a sharp rebound in earnings.
But I'm not buying it. In fact, I'm selling it.
Regards,
Dan Amoss
for The Daily Reckoning
The commercial real estate crisis may be the most anticipated crisis in history. But just because it's widely anticipated doesn't mean that the crisis won't be destructive for REIT shares. Since most REITs are richly valued, the slow-moving commercial real estate crisis will ensure that future returns disappoint.
Consider the valuation of REITs versus the S&P 500, which itself is overvalued. Despite being 25% below its late 2007 peak, the US stock market - measured by the S&P 500 index - is very expensive. The "Shiller P/E ratio," developed by Yale professor Robert Shiller, measures the S&P 500 against the average S&P 500 earnings over the previous 10 years, adjusted for inflation. It's a much more robust measure of valuation, considering the fluctuation of corporate earnings, and the fact that after bubbles, much of the earnings booked during the boom are written off during the bust. Consider that the earnings booked by Citigroup and other big banks near the peak of the bubble were largely written off during the bust. Therefore, a 10-year average of earnings is a better indicator of true earnings.
The Shiller P/E ratio for the S&P 500 Index is now 21 - up dramatically from 13 at the March 2009 lows. This 21 P/E is higher than at almost any point in stock market history, outside of the late 1920s bubble, the late 1990s bubble, and the market peak in 2007. The S&P 500 is overvalued based on the Shiller P/E, but corporate earnings are supposedly going to soar in 2010, right? Well, even if you believe the optimistic 2010 estimates, the market is still more than fully valued on that metric.
Ditto REITs.
Commercial real estate - and the REITs that hold commercial properties - began to deflate rapidly in late 2008. But the Fed stepped in with bailout funds and easy money to halt the deflation...and even pumped the bubble back up a bit. The nearby chart shows the results of the Fed's handwork. REITs of all shapes and sizes more than doubled off the stock market lows of last March, while the Bloomberg Hotel REIT Index more than tripled. (We'll come back to this chart a little later).
 |
This rally has the look and feel of a dead-cat bounce, which means that it provides an attractive short-selling entry point.
REITs soared as the bubble inflated from 2000-2007, then crashed when the bubble popped in 2008 and early 2009, and then launched a dead cat bounce when the Fed flooded the system in mid-2009 with massive injections of liquidity and cheap credit. Now REITs are priced at bubble valuations - valuations that bear little resemblance to economic reality.
This bounce has postponed a healthy purge of assets in which old capital invested by foolish speculators during the bubble would have been wiped out - clearing the way for new owners to assume title to real estate at reasonable prices. When central banks prop up deflating bubbles with super-easy bailout cash, the bubble investors don't liquidate their overly inflated assets. They hang on and hope for a turnaround.
But bubbles always deflate...always. Government intervention merely muffles the hissing sound for a while. This story played out in the Japanese real estate bubble that peaked in 1990, and it's happening with the US commercial real estate bubble that peaked in 2007. Capital becomes trapped in a dead asset class, thereby stretching the bubble's resolution out over decades.
Toward the end of 2009, it became clear that "extend and pretend" had become the official policy at most banks that hold commercial mortgages. We won't see a cleansing flush of hundreds of billions in underwater properties changing hands to new owners. Instead, properties will be dribbled out of the foreclosure pipeline at a slow pace. This measured pace of foreclosures will add to the chronic glut of property that will be quickly listed for sale into any bounce in demand.
Some of the best short-selling opportunities in the REIT sector may be in the hotel REIT sub-sector.
It's not a stretch to expect the hotel business will be ugly for a long time. Corporate and leisure travel is in the midst of a depression. And leveraged hotel owners built or acquired too many hotels near the peak of the commercial real estate bubble.
Now many hotel owners are desperate to generate cash in order to pay down debt and retain titles to properties. Some are slashing nightly room rates below break-even levels. You know from the growth of Internet hotel booking services just how much more competitive and transparent hotel pricing has become over the past decade. Unless competitors are willing to match the pricing of the most desperate hotel owners, healthier competitors will suffer lower occupancy.
Some levered hotel owners, like Sunstone Hotel Investors, are abandoning their equity in some properties to salvage others. In the fourth quarter of 2009, Sunstone defaulted on several nonrecourse mortgages held against 13 of its properties and turned the title over to its lenders. Sunstone calls this a "deed-back," but it's really a strategic default.
Sunstone's lenders will probably keep and operate the hotels, rather than dump them at a distressed price. The behavior of Sunstone and its lenders shows how many hotel owners and lenders are putting off the necessary liquidation of underwater properties with bloated cost structures. The industry still needs to make more progress on downsizing, slashing operating costs, shrinking mortgage sizes, and lowering room rates to match demand. Until it does, the industry's returns on capital will not consistently exceed its cost of capital.
Hotel REITs are highly sensitive to perceptions about the near-term health of the hotel business. Trends in occupancy and room rates shape perceptions about earnings. Hotel REITs own portfolios of hotels and outsource the management to companies like Marriott for a fee.
Because of the relatively fixed costs of paying management companies a fee for operating hotels, Hotel REITs operate with high operating leverage: A 20-30% decline in revenues can translate into a 50-75% decline in operating income. Also, unlike offices or retail REITs with sticky long-term leases, the cash flow for hotel REITs adjusts quickly to changing conditions on a day-by-day basis.
Over the past nine months, hotel REITs have soared on the perception that corporate and leisure travel will rebound strongly in 2010 and 2011. Analysts have forecast a sharp rebound in earnings.
But I'm not buying it. In fact, I'm selling it.
Regards,
Dan Amoss
for The Daily Reckoning
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