Why Investors Can’t Ignore a Rebounding Japan

By: Money_Morning

Martin Hutchinson writes: In a visit to Japan in the early 1990s, U.S. President George H.W. Bush threw up over the Japanese prime minister. When President Barack Obama visited Japan last weekend, he offered an effusive bow to the Emperor Akihito.

Politically, U.S.-Japanese relations have improved dramatically during that two-decade stretch.

Yet investor regard for Japan has gone the opposite way. Twenty years ago – in the midst of the Japanese stock-and-real-estate bubble – U.S. and other world investors were kowtowing to Japanese investments – and banging their heads on the floor in the process.

Today those same investors are much more likely to throw up in the direction of those Japanese investments.

The up-chuck response to Japanese investment is a reasonable one, given that country’s stock-market performance since 1990. After all, the Nikkei 225 share index is down more than 75% from its January 1990 peak. If my broker had locked me into Japanese stocks for the last 20 years I’d probably beat him about the head with the performance report, too.

As Japan fans have been saying for the last decade, the market is a much better buy with the Nikkei at 9,000 than it was when the index was at 39,000. Needless to say, that hasn’t enhanced Japan-backers’ credibility as the market has meandered around without a trend, performing similarly to Wall Street during the period overall, but without the excitement of hitting all-time highs even in 2007.

Japan’s stock market will only recover when Japan’s economy shows some signs of real growth. The good news, however, is that real growth may be resuming. Japan’s third-quarter gross domestic product (GDP) rose at a 4.8% annual rate, after revised growth of 2.7% in the second quarter. That puts it well ahead of the U.S. recovery, and means that Japan is outpacing the rebounds of most of the European Union, the other comparably rich bloc of countries.

Japan’s recession was very different than those suffered by the United States, Great Britain or most European countries. It had already suffered a banking meltdown during the 1990s, and had experienced no significant real estate bubble this decade. Thus, the only new bad debts in the Japanese banking system were the few it picked up from dabbling in the U.S. and British housing markets – investments that were foolish, but not significant in terms of the Japanese economy as a whole. Even Nomura Securities (NYSE ADR: NMR) – the most dedicated unprofitable dabbler in Western markets – scored a notable success in October 2007, when it wrote off its entire participation in the U.S. subprime-mortgage market. That write-off gave it one bad quarter, but left the remainder of its operations in good shape.

Even during its recession, Japan has had a better productivity performance than the United States or Germany, its principal rich-country rivals. From 1990 to 2008, Japan’s labor productivity increased by 39.7%, just fractionally better than the United States at 39.1% and significantly ahead of Germany’s 32.6%.

Thus, while the 1990s and 2000s were for most of the time an era of U.S. economic triumphalism and Japanese despair, neither was really warranted. During the 2008-2009 downturn, Japan’s principal problem was an export decline that reached 50% at its nadir – because of the yen’s strength against the dollar and most of the other major trading currencies.

In the period since March, Japanese exports have rebounded nicely. But unlike its U.S. counterpart, Japan continues to enjoy a balance-of-payments surplus and a strong yen.

The new Democratic Party of Japan government – led by Yukio Hatoyama and elected on Aug. 30 – is pledged to shift Japan’s priorities away from exports and infrastructure spending and towards the domestic economy. The government has already cancelled a substantial chunk of the previous government’s heavy infrastructure program and has pledged to introduce monthly allowances of about $300 per child to families with children. That will increase domestic spending, and should helpfully reorient the Japanese economy towards the small business sector.

Japan’s major problem is the government deficit and the debt that accompanies it. Its public debt is now 200% of GDP, although that ratio will come down if GDP improves strongly. The DPJ finance minister, Hirohisa Fujii, is pledged to substantial budget savings, and the rebound in GDP should reduce the pressure for more “stimulus.” Then you have to remember that with its high savings rate and payments surplus, Japan’s government debt is owned primarily by the Japanese people. So in this area, too, Japan is better-placed than many other countries.

With other East Asian countries – notably China, South Korea and Taiwan – rebounding nicely, Japan is poised to show good growth in 2010, far better than the Economist’s estimate of 1.5% GDP growth.  The wise investor will thus keep a portion of their money in Japan, concentrated in domestically oriented companies – it is, after all, still the world’s second-largest nominal economy.

Money Morning/The Money Map Report

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