There is daily evidence that the global credit crisis is far from over. Financial markets have also begun to discount a global recession of as yet unknown magnitude. With the bear market already underway, the best that investors can do is prepare for the worst while hoping for the best.

Even hedge funds are having a hard time of it. Momentum traders got burned by a reversal in the short financials and dollar/long commodities trade, and could be whipsawed as the trade reversal reverts back to the long-term trend, i.e., weak US dollar, strong commodities.

Despite the US being the epicenter, US stocks are actually holding up better than other international markets. While foreign investors and global strategists became upbeat on Japanese stocks (particularly the banks) ostensibly were expected to weather the current global financial crisis better than their US and European peers, Japanese stocks have been weaker than US and UK stocks.

The profitability of major Japanese banks remains largely determined by BOJ interest rate policy, not business strategies. Further, the three Japanese megabanks have actually been destroying shareholder value (market capitalization) since 1997. Then, the nine predecessor banks had market cap of some JPY27 trillion. Now, the three megabanks have combined market cap more like JPY20 trillion, which is 41% less than at the end of 2006. In other words, market cap is now lower than at the height of Japan’s financial crisis!

To us, they look more like a value trap than a way to hedge downside risk in US/European financials, even through their balance sheets are much healthier than global peers and they are ostensibly in a position to restore their global presence lost during the Heisei Malaise. 

In our view, the globalization opportunity for Japan’s major banks does not equal an investment opportunity. The major three are down 50% over the past 52 weeks and have underperformed the Nikkei 225 by 30%. With Japan slipping into recession, we don’t see how this makes the fundamentals of Japanese bank stocks more (instead of less) attractive.