How to Invest in Japanese Stocks

The Japanese stock market has a remarkable history, and its booms and busts have had global economic and political repercussions. The Nikkei-225 went from 86 in June 1950 to almost 40,000 in December 1989, with a 600 percent rise in the final seven years of the bubble. For a time, Japan accounted for 45 percent of the entire global market cap; the 1990s saw it shrink from being larger than the US to a fifth the size. Much of the Western media likes to refer to 1987 as the year of the crash; far more significant was the Japan crash of 1990. Now, 10 years later, with technology, deregulation, and restructuring leading the way, Japan appears to be on the road to recovery.

In this article, we are not going to get into the intricacies of Japanese stock picking or an analysis of the Japanese economy and its sectors. Neither are we going to recommend specific brokers. What we are going to do is offer some pointers on how to actually go about investing. The mechanics, the process, the differences with overseas markets that will concern you, and the information sources that will help you. We have assumed the reader has some knowledge of US stock investing both online and off, but little knowledge of Japanese stocks. Obviously there are numerous Japanese investment trusts and US mutual funds covering Japan, but in this article, we are focusing on investors who manage their own investments.

Overseas Japanese listings and ADRs
First, if you just want exposure to Japan and a few major stocks, you can use your overseas-based account. Perhaps the best US-listed proxy for the Japanese market is the World Equity Benchmark, EWJ, which trades just like a stock -- it can be bought and held, day traded, short or long. Two closed-end Japan funds exist, the Japan Equity Fund (JEQ) and the Japan OTC fund (JOF). If you don't have the time or inclination to study individual Japanese stocks, but just want exposure to the Japanese stock market in general, try these.

In the US, many major Japanese companies have full listings or liquid ADRs [certificates issued by a US depositary bank representing foreign shares held by the bank, usually by a branch or correspondent in the country of issue]. Among them are NTT, SNE, HIT, KYO, ICYOY, TM, HMC, NSANY, CANNY, FUJIY, MBK, IX, and TKIOY. Uniquely for Japanese stocks (so far), IIJI is listed only in the US. Many other Japanese companies have an illiquid OTC ADR, but these are much better to trade in Tokyo, unless you do not mind the wide bid-offer spread and are just going to buy and hold. Bear in mind the effect of foreign exchange fluctuations on US-denominated Japanese stocks.

Selection of broker
So far brokers only have sites in Japanese, just as US-based brokers only have sites in English. This may change of course. Make sure you choose a broker whose site functionality and reliability suits you. Paying a low ¥1,000 or ¥2,000 a trade won't help if that broker's site goes down or fails to execute a trade and costs you a few million. Everyone seems to prefer a different broker, so read surveys, talk with friends, and choose two so that you have a back-up. Online brokers are launching, adjusting their pricing structures, enhancing their services, and offering promotions frequently. Most offer fairly comprehensive news, information, and research and charting capabilities, although, like the US-based online brokers, their services are limited to keep costs low. Don't ignore the traditional guys like Nomura, Daiwa, Nikko, and other domestic securities houses. Unlike the US experience where the traditional brokers were slow to offer online trading, these have all offered Internet trading for the past couple of years. Their commissions are much higher, of course, but most employ English speakers, their information and research is superior, and they will give you more help on the steep (and treacherous) learning curve of Japan stock trading.

What next
When you have checked out several brokers, register online or by phone and you will receive some forms (in Japanese) to fill in through the mail. Choose at least two to wire money to. If you can't read Japanese get a trusted friend who can to guide you through their sites and to fill in the forms. Order entry is so straightforward that learning to do it yourself is easy, and the screen kanji will rapidly become familiar. Broker's screens differ, but basic inputs are the four-digit stock code (which is used in Japan instead of letter-based ticker symbols like MSFT), buy or sell, how many, and at what price. You will also be asked to specify whether the order is only for the day or GTC. You have two tax choices, which I'll go into below. You'll receive a user-name, password, and a dealing password, but you should choose your own once the account is set up.

The basic mechanics of trading Japanese stocks are similar to overseas. Whilst there are numerous differences "under the hood," these should not overly concern you. One great benefit is the dealing times are very civilized, with just a few hours for actual trading and a break for lunch in the middle, which gives you a great time-out to reconsider your positions if you are a short-term trader. The exchanges consist of the TSE 1st and 2nd sections, the OSE (Osaka Stock Exchange), assorted regional exchanges like the Nagoya and Sapporo, the Jasdaq or OTC, the much heralded Mothers, and a Green Sheets market which is vaguely similar to the US pink sheets. Nasdaq Japan should open in June. The Sapporo exchange recently announced a startups market dubbed "Ambitious" for mainly Hokkaido-based firms. Most online brokers in Japan let you trade on all these exchanges.

So far ECNs do not exist in Japan. Having already much enhanced liquidity and reduced spreads in the US markets, they'll soon appear in Japan. Already Mitsui, Monex, and DLJdirect-SFG have announced an initiative. Also, Nikko has a joint venture with market-making specialist Knight-Trimark. This will further liquefy the markets and bring about after-hours trading sessions.

The three main differences from US trading that will concern you are:

1. Minimum trading units. Until recently the minimum trading unit for most Japanese stocks was 1,000 shares. For high-priced shares, even getting into the game required tens of millions of yen. This is finally being reduced to a more manageable 100 shares, or even 10. The ultra high-priced shares like Yahoo Japan and Internet Research Institute trade in 1-share units. Eventually, as some of the archaic restrictions are dropped, such stocks will one day do a 1:1,000 or even 1:10,000 stock split, increasing liquidity and becoming buyable by normal investors. It hardly engenders the public's faith in the Japanese stock market to have some of its most newsworthy stocks unbuyable by normal investors. Keep in mind that keeping stock relatively scarce has long been a feature of the Japanese markets.

2. Price limits on each stock. In general, a stock is only allowed to move within a maximum daily limit. Whilst designed to curb speculation, it is becoming a more prevalent occurrence for stocks to "lock limit" up or down, especially as more Japanese Net stocks go public. If a flood of buy orders comes in, the stock can go "limit up" on the open and stay there all day. Whilst the US has curbs and time-outs in place on indices if Armageddon ever hits, there is nothing on individual stocks. The result in Japan is that for a stock you want to buy, you may have to watch in frustration for days before you can actually get in, especially with IPOs. Also, you may not be able to get out easily on the downside when a hot stock suddenly turns cold and goes offered only.

3. Taxation. Japan is generally regarded as a high-tax country. For income tax it certainly is, but for capital gains it is advantageous. When you buy a Japanese stock you have two choices: (1) you pay 1.05 percent immediately regardless of what ultimate direction the stock goes, or (2) you pay 26 percent of your capital gains, if any. Obviously the choice to make is the first; unfortunately, this method will be abolished in April 2001, so, as they say, "Make hay while the sun shines."

Trading characteristics
Perhaps even more than in the US, you must be cognizant of the global and Japanese economic environment. You must understand the role that interest rates and foreign-exchange movements can have on the stocks you are trading.

Japanese traders, especially individuals, love technical analysis and charts. Even if you are a pure fundamentalist, you must still be aware of key price points and trends. For consistent success, you need to be acquainted with support and resistance, trend-lines, and Japanese candlestick charts.

Japan stocks move in well-defined themes, and these can change quickly. Scarcity value magnifies demand and price movement. When I started investing in the Japanese Internet, there were basically two publicly traded stocks (Softbank and Yahoo Japan); now there are 15 to 20, and in a couple of years there will be 200 to 250. So far, differentiation has not been a major factor, but it will be. Try to specialize in stocks you know about; get familiar with their businesses and trading patterns.

Getting in on Japan IPOs
At the beginning of 2000, a lot of people asked me what the best performing Japan stocks of 2000 would be. My reply was I didn't know since none had gone public yet. Plainly the potential 1,000 percent and 2,000 percent gainers in Japan will be newly listed stocks. However, it is not easy to get in at the IPO price, just like anywhere else. The supply of stock is kept very low and, of course, where the Net is concerned far more investors want in than will get an allocation. No one -- not Nomura Asset Management, not Fidelity -- gets all they want, and neither will you. But there are ways to create a higher chance. Due to Softbank's portfolio of upcoming IPOs for its numerous companies, E-trade Japan is highly likely to get allocation for retail clients. In July 1999, Softbank Technology went IPO and E-trade selected those who wanted in (everyone!) by lottery. A similar process occurred for Internet Research Institute.

Some of the other online brokers are increasing their capital to a high enough level to be an underwriter so they can distribute new issues to their clients. Also, firms like Wit Capital are attempting to further democratize the IPO allocation process in Japan.

The line between private and public equity is however blurring in this country. D-Brain Securities operates VIMEX, where the shares of private Japanese companies can be traded.

Information sources
In English, the information sources are limited but adequate for making trading decisions. Of course, being able to read Japanese is an advantage, but there is English-language information around.

• The best starting point is the two-volume Japan Company Handbook published by Toyo-Keizai. This gives a tremendous amount of information on every public stock in Japan and is well worth the ¥9,000 investment. Learn the stock codes and businesses of those companies that interest you. Time spent with these books will help greatly in your investing.
• The Nikkei Weekly newspaper and English site: www.nni.nikkei.co.jp.
• English-language newspapers like The Japan Times or Daily Yomiuri have stock commentaries, although not much OTC coverage where a lot of the recent action has been. Western business and financial magazines have regular articles on Japan now that it is back in vogue.
• Quote.yahoo.co.jp (http://quote.co.jp) is usable (just about!) by a non-Japanese reader.
• A book called 100 Samurai Stocks by Henry Scott Stokes came out in early 1999. This gives an excellent potted commentary of 100 interesting Japanese companies likely to benefit from the new Japan. The timing of this book's publication was apt to say the least; almost as if Western fund managers added all 100 stocks to their lists. Many of those written up appreciated several hundred or even a thousand percent during 1999. Obviously it does not include 1999 IPOs, but it is still a useful resource for ideas.
• Many foreigners in Japan either work in finance or have a friend who does. English-language analyst reports can often be got hold of and you will gain a deeper understanding of the companies you are trading. Just make sure you ignore the buy (or hold) recommendation and make your own decisions. Also, more companies are producing annual reports in English. Of course if you are Japanese or can read it, the information sources are vastly more comprehensive.

Conclusion
Whilst of course there are dangers, I believe Japan will offer tremendous investment opportunities in the coming years, possibly even exceeding those of the equity markets in the '80s or bond markets in the '90s. Like most worthwhile tasks, successfully investing in Japanese stocks is a steep and expensive learning curve. Nevertheless, for those who put in the time, it will be worth it. Good luck!