Buy Japan - But Beware of These 3 Investment Aftershocks

by: Lou Basenese

As the tragedy in Japan unfolds and worsens in terms of the human cost, it was little surprise to see the Nikkei 225 stock exchange tumble by 6.2% on Monday. It was one of the steepest declines on record, with the selloff filtering to other global markets later in the day.

Clearly, nobody knows what to make of the devastation in the world’s third-largest economy, but let me cut to the chase for you: If you’re invested for the long-term, buy Japan.

And here’s why…

Three Reasons to Bet on Japan

Japan is already one of the cheapest markets on the planet. For example, the average stock on the TOPIX trades at a price-to-book ratio of 1.0 – a 56% discount to the average U.S. stock.

The swift move by the Bank of Japan to inject $187 billion in liquidity into the market sends a clear message, too: It’s going to aggressively fight the onset of any true financial panic.

And in a couple weeks, the resilience of the Japanese people is going to kick in, as rebuilding efforts begin in earnest. There’s a precedent for this, too. With the Kobe quake in 1995 as our guide, any dip in industrial output promises to be short-lived. In fact, it should last less than a couple months, based on this chart from Societe Generale and Business Insider.

click to enlarge

Month-Over-Month Change in Japan
Add it up and any significant downside risk for the broad Japanese market simply doesn’t exist. All the bad news is reflected in current prices.

If you're a conservative investor I'd consider the iShares MSCI Japan Index Fund (NYSE: EWJ). It's overweighted much more to large cap Japanese stocks. If you're willing to be more aggressive, though, consider investing exclusively in Japanese small cap stocks via the Japan Smaller Capitalization Fund (NYSE: JOF). It's a closed end fund and is currently trading at a small discount to NAV.

Key Concerns for Short-Term Investors

In the short-term, however, expect volatility to be the norm for these five areas of the markets, not entirely isolated to Japan…

1. Uranium: The meltdown at the Japanese nuclear sites certainly isn’t this century’s Chernobyl. They rank as a four on the nuclear disaster scale, compared to a seven for Chernobyl.

But perception is reality. And right now, people don’t consider nuclear power safe anymore. As a result, uranium stocks are getting clobbered, selling off by double-digit margins.

If the nuclear impact worsens, or human emotion grabs hold of energy policy, watch out. Trading in uranium miners like Paladin Energy (OTCPK:PALAF), Cameco Corp. (NYSE: CCJ) and Denison Mines Corp. (AMEX: DNN), among others, promises to be extremely volatile.

2. Insurance Stocks: Moody’s Investors Service Inc. and Fitch Ratings expect losses to rank among the largest in history for insurance and reinsurance companies worldwide.

At this stage, though, the total cost remains a complete unknown. So investing in insurance stocks with sizable Japanese exposure like Prudential Financial (NYSE: PRU) and Manulife Financial (NYSE: MFC) is akin to spinning the wheel at the Roulette table in Las Vegas. Don’t do it, unless you like terrible odds.

Also consider avoiding Aflac (NYSE: AFL). Although it isn’t exposed to the property and casualty market, it generates 70% of its profits from medical and life insurance in Japan. The impact on such markets could be delayed.

3. Emerging Markets: In our world of globalization, you can bet that Japan’s tragedy is going to take an economic toll on other countries, particularly emerging markets in the region.

For example, over 200,000 Filipinos work in Japan and regularly send money home. Thailand relies on one million Japanese visitors each year to generate significant tourism revenue. And countries like Indonesia regularly rely on Japan for investment in infrastructure projects.

That money could obviously now be redirected to reconstruction efforts. Even China’s economy isn’t immune, as Japan ranks as the third-largest destination for Chinese exports.

In the end, investors always tend to sell first and ask questions later. If you’re a long-term investor, such behavior spells opportunity in Japan. On the other hand, if you’re a short-term trader, such behavior could result in quick losses. Invest accordingly.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.