Japan, Land Of The Rising Stocks

by: Nico Inberg

The Japanese Nikkei-225 is doing great this year. From the beginning of this year, the Nikkei already increased by 45%. To a large, extent this is due to the falling yen, but corrected for the yen decrease, there is still an impressive 25% profit. At 15500, the Nikkei looks quite high, but the Japanese index was much higher at the end of last century. The Nikkei set a high in December 1989 of 38957.44, 24 years ago. On March 9th, 2009, the lowest point was reached, 7054.98.

Looking at the above chart, we see a huge spike in the late 80s followed by an equally steep decline in the early 90s. The bubble in the Japanese housing snapped in the early 90s. People lost confidence in the financial system and banks had to be rescued with public money. Sounds familiar? So far it seems. The current crisis came the same way.

By lowering interest rates, the Japanese government tried to get the economy going again, but a creeping deflation established a zombie economy: little or no growth and postponed consumption. Then, late 2005, it finally looked like the end of the real estate crisis was in sight but three years later Japan fell back due to the current financial crisis.

Since the (re)appointment of the current president Abe, the Japanese stock market seems to accelerate again. Abe introduced a recovery plan called Abenomics. His plan consists of three main topics:

• Drastic monetary easing

• Fiscal stimulus

• Structural reforms to stimulate growth

The cheap yen has at least ensured that Japanese investments in Asia increased by 22%. In addition, exports increased very fast and that benefited the profitability of the Japanese companies. Although the drastic monetary easing could bring the economy at risk, for now it seems that things are working out fine. For the longer term, Japan is highly dependent on the growth of the world economy. In addition, there is the danger of too much inflation. 2 to 3% is perfect, but if it overshoots to 4 or 5% Abe will find himself in a very precarious situation.

The opportunities for Japan for the short and medium term, are driven by several factors:

Export growth

Japanese firms strongly benefit from the cheap yen. The increased export volumes improve the profitability of the Japanese companies. We have to keep in mind that the profits are made in yens, converted to US dollars, it might be less than expected. Because of the low interest, Japanese companies might be seduced in using their excessive cash for share buybacks, which could in time be an extra driver for the stock market.

Loose monetary policy

The current loose monetary policy of Japan will certainly continue for several years. That is a boost for the stock market. The BOJ, Bank of Japan, is not only buying government bonds but also purchases property and indextrackers! This is supporting the stock market. All things considered, the Japanese are more aggressive in their stimulus than the Americans.

Restore confidence in domestic market

The Japanese are accustomed to lower prices for twenty years now. Prime Minister Abe's most difficult challenge is to convince his population that they have to prepare themselves for inflation. If Abe succeeds, the Japanese people might finally start spending money, which could be the ultimate driver for the domestic consumption. However, we must take into account the fact that Japan must import much of its energy. The cheap yen also means that imports are getting more expensive.

What are the best Japan ETFs?

For those investors who want to profit from a probable further increase of the Japanese stock market, the best thing to do would be to invest your money in a Japan ETF. The two most widely traded ETFs are:

EWJ iShares MSCI Japan Index Fund : $12.1 billion AUM (NYSEARCA:EWJ)
DXJ WisdomTree Japan Hedged Equity Fund : $10.4 billion AUM (NYSEARCA:DXJ)
The cost for these ETFs are around 0.5%.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.