Japan: A lot of Idle Cash 'Gradually' Flowing into Stocks

The markets are closed today in Japan for a national holiday celebrating those "coming of age" (20 years old). There's quite a bit to be happy about this year as unemployment is low and the economy continues to expand.

I came across an interesting article over the weekend originally published by the Jiji Press, entitled "Japan Households Gradually Shifting Savings to Investment." Among the key factors for Japanese stocks include: channeling a higher portion of household assets to equities and higher wage growth leading to a virtuous cycle. A discussion of the article and investment ideas follow.

In the U.S. we often hear of all the potential of money sitting on the sidelines and how it could be a huge boost for stocks in terms of keeping the bull market going.

In Japan, there's a similar argument, but one that has much more profound implications.

Consider that among household financial assets, 30.8% in the U.S. is invested in equities, whereas only 10.7% is in Japan. The article did not mention how much of U.S. household assets are invested in mutual funds, but it is likely to be a substantial amount, greater than the direct investment in stocks.

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In Japan however, investment trusts (mutual funds) make up only 4% of household assets and that's as of the end of this past September following a 33.6% increase to a new record.

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The Japan-related data is from a preliminary report by the Bank of Japan (as of Sept. 30, 2006). Outstanding financial assets at households totaled ¥1,495 trillion ($12.6 trillion at ¥118.75/$1). Cash and deposits made up 51.3% of assets at ¥767 trillion ($6.5t), equity shareholdings were 10.6% at ¥159 trillion ($1.3t), investment trusts were 4% at ¥60 trillion ($505b) and Japanese government bonds were 2% at ¥30 trillion ($253b).

In Japan a strong preference for "safe" income yielding assets will likely remain. This doesn't seem so bad considering the near 12% y-o-y growth in equity ownership and near 34% increase in allocation of funds to investment trusts. I will admit it is still frustrating though, because of the heavy marketing in Japan that attempts to lure cash (that is potentially money that could be invested domestically) to chase high yield bonds and currency deposits overseas, as well as throw money at emerging stocks in China and India (I guess you can't blame them after the very handsome year-end returns in these two markets last year).

At any rate, I think the whole point and investment implication of this article and the data boils down to two things: (1) you want to keep in mind what firms will manage household assets and (2) consider the impact of even greater liquidity. Therefore, I think the top stock plays for American investors are Mitsubishi UFJ Financial Group (MTU), Mizuho Financial Group (MFG) and Nomura Holdings (NMR). It is Mitsubishi and Mizuho's game to lose so to speak, because they already have substantial household deposit accounts along with rival mega bank Mitsui Sumitomo (SMFJY.PK). But remember, this is actually not a zero sum game.

In terms of new money making its way into equities, I think the default play is iShares MSCI Japan Index ETF (EWJ) simply because of its low fees and liquidity. That said however, there were some new Japan ETFs launched during last year that strongly outperformed EWJ and are worthy of consideration (see related post -- scroll for discussion and chart). I am referring specifically to WisdomTree's (WSDT.PK) Japan: Small-Cap Dividend fund (DFJ), High-Yielding Equity Fund (DNL) and Total Dividend Fund (DXJ), because of their emphasis on dividends and Japanese hunger for yield. Blue chips and yield are a good bet with Japan.

Lastly, I would advise building a position in any ETFs or stocks as opposed to making a lump sum investment. After the December rally in Japan and overall strength in Asia in '06 (and even the nice returns in the U.S. in '06) it looks like we could be in for a bumpy Q1 with profit taking, some sectors falling out of favor and subsequent rebalancing, and ever more scrutinizing of market and political-related events across borders. Forex will be imporant too, as the yen could appreciate against the dollar with any BoJ hikes, which would help the cause of American investors in Japan ADRs and ETFs.

Recommended reading: Japan: 2006 Year in Review, 2007 Outlook, Japan: 2006 Market Cap Ranking

Disclosure: The author owns iShares Japan call options. The author is not long/short any other funds or stocks mentioned.

Comments

[Mr Mister:]

I thought stock market growth is driven by earnings.

2007 Feb 26 09:04 PM