by Carl Delfeld, Investment U’s Global Equities and Emerging Markets Specialist
Thursday, April 14, 2011: Issue #1491
The bear case for Japan is well known: high debt, slow growth, an aging population, gaping budget deficits and dysfunctional politics.
To many investors, Japan’s economy seems like yesterday’s story, while emerging markets look like the future.
But there are two sides to every story, and the case for keeping some Japan exposure in your portfolio is clear and compelling.
Here are a baker’s dozen of reasons why ignoring Japan may be a mistake…
13 Reasons Japan Still Has a Bright Future Ahead
- Japanese companies and local banks are flush with cash. Deposits at Japanese banks exceed outstanding loans by $1.8 trillion.
- Approximately 95 percent of Japan’s $10-trillion sovereign debt is held by Japanese investors. It’s not dependent on the whims of foreign lenders.
- The country’s current gold and foreign exchange reserves of more than $1 trillion are second only to those of China.
- Japan is quite possibly the only developed economy in the world to pull off trade surpluses with China, Taiwan and South Korea.
- Japan’s creative spirits are alive and kicking. The country still grabs U.S. patents at a rate double that of the Koreans and Taiwanese together.
- The strong yen is giving Japanese companies the upper hand in grabbing overseas companies and commodities at reduced prices.
- The forward 12-month price-to-earnings ratio that peaked at 70 in 1989 is now only 13.6 for Japan’s entire market (Topix index).
- Share prices in Japan are just above book value compared with double book value in the United States.
- Peter Tasker of Argus Research finds that 25 percent of Japan’s companies trade at less than 10 times earnings compared to just 4 percent for the S&P 500 index.
- On a price to sales basis, Japan trades three times cheaper than a basket of the BRIC markets (Brazil, Russia, India and China).
- Japan’s market beats its own drum. Having holdings tied to Japan in your global portfolio is a great diversifier. Over the last ten years, Japan has moved in sync with the S&P 500 only 30 percent of the time.
- Japan’s government is injecting liquidity into the economy to offset the effects of the quake and tsunami and is proposing a cut in corporate tax rates.
- Finally, keep in mind that Japan is still the world’s third-largest economy – just a hair behind China. A huge economy like Japan’s will not post headline-grabbing double-digit economic growth but can still deliver sizable profits and cash flow.
How to Add Japan to Any Global Portfolio
Investors wishing to add a dash of Japan to their global portfolio should consider coupling the iShares MSCI Japan Index Fund (NYSE: EWJ) with the Wisdom Tree Japan Small-Cap Dividend Fund (NYSE: DFJ).
With EWJ you will get exposure to Japan’s largest companies that tend to be export oriented. A modest weakening of the Japanese yen should really give these firms a boost since it makes them more price competitive in overseas markets. DFJ is more of a play on Japan’s consumer sector and the smaller industrial companies that support Japan’s leading companies. There’s no hope that the Japanese consumer will resume the big-spending traits so evident in the 1980s. Still, even a marginal improvement in consumer spending could trigger a rally.
Keep in mind that it’s a distinctly contrarian play, but it’s something to consider. The biggest concern that I have about Japan is that the yen may be significantly overvalued relative to Japan’s balance sheet and growth prospects. However, on balance, some exposure to Japan makes sense for most investors.