Japan’s Surprisingly Strong Economy Makes it a Great Global Play
By Martin Hutchinson
Chief Global Investing Strategist
Global investors should take heed: Japan’s economy continues to be much stronger than it looks.
When the world’s No. 2 economy reported its second-quarter performance on Monday, the figures were largely viewed as a disappointment; they showed economic growth of only 0.1%, or 0.5% on an annualized basis. That’s down from a revised growth rate of 3.2% for the first quarter, and was well below the median estimate of 0.9%, according to a survey of 27 economists surveyed by Bloomberg News.
With growth having slowed even more dramatically than economists expected, investors are fretting that it’s now much less likely that Japan’s central bankers will boost interest rates when they meet for two days next week.
Unfortunately, those fretting investors are focusing on the wrong elements of Japan’s prospects.
The Case for Japan
There are many sound strategies for investing internationally. One, which we advocate wholeheartedly here at Money Morning, is to “follow the money” – that is, ferret out the investment flows that point to the best profit opportunities. Another is to track what other noted global investors are doing, and following in their footsteps.
But one of the best is to pick out a country with terrific prospects, and then look for the best investments that nation has to offer. This so-called “top-down” approach to investing can be quite effective.
Especially when the country in question is as solid and promising as Japan.
In breaking down the second-quarter growth figures, we see that Japan’s consumption growth slowed from a 3.2% rate in the first quarter to a 1.6% rate in the second. Private-sector investment, on the other hand, was strong; it grew at a 4.8% annualized pace, up from 1.2% in the first quarter. (Don’t forget that Japan – unlike the United States – has no population growth, so a 2% growth rate in Japan is reflective of real growth; whereas in the U.S. market, a 2% economic growth rate represents true growth of only 1% – net of the 1% annual growth in the American population.)
Thus, in many respects, Japan’s economic position is the reverse of the U.S. economic position of 2005. Whereas U.S. consumption in 2005 was strong, it’s actually fairly weak in Japan, growing no faster than the overall economy. Conversely, whereas the U.S. economy of 2005 had to struggle against weak investment totals, investment in Japan today is quite strong, as this key Asian nation re-equips itself after 15 years of recession.
Housing, too, was a strong contributor to the U.S. economy’s overall vitality in 2005. But in Japan, it is very weak today, with private residential investment down in the second quarter at an annual rate of 12%.
In terms of government spending – always an interesting area to analyze – the United States of 2005 and Japan of today are uncannily once again mirror images of one another. Whereas public spending was increasing rapidly in the United States in 2005, it is flat in Japan, where public investment actually plunged by an 8.4% annual rate in the second quarter. This accounts for much of the decline in GDP growth, and reflects the tight fiscal policy in the Japanese budget propounded by Prime Minister Shinzo Abe at the beginning of the year.
Public-spending restraint is never popular, but in Japan’s case it is vital to rebuild public finances, and to allow the private economy to increase at a healthy rate. One of Japan’s major problems in the 1990s was that the rapidly expanding public sector was growing faster than the economy, leaving little or no room for private-sector expansion. This position is now reversing, as the public sector shrinks its share of the economy and the private sector correspondingly expands. Japan still has public debt of about 160% of GDP, but most of that is held in various domestic savings funds.
Some Top Plays on Japan
So it depends what you like. If you like a country where people spend more than they earn, government expands more rapidly than the economy, house prices and investment roar ahead and business investment is sluggish because of massive overbuilding in a bubble a few years earlier, you’ll prefer the 2005 version of the United States.
If, on the other hand, you prefer a country where people save, private consumption is restrained, housing is subdued, the government is keeping a tight rein on wasteful spending, and business investment is booming after a 15-year recession, you’ll prefer Japan. It’s all a question of investor tastes.
I know which way my tastes run. For those who agree with me – and who like to carefully manage their risk – I would suggest the streetTracks SmallCap Japan ETF (AMEX: JSC). As this illustrates, on the whole I prefer smaller companies, which can benefit from continued growth in the Japanese economy without being buffeted by international problems. But there are some very interesting larger plays, too.
Of the larger companies, Toyota Motor Corp. (NYSE-TM) warrants a close look, if only because it’s trading at a very modest 13 times earnings – and because it’s steadily eating the global lunch of U.S. stalwarts General Motors Corp. (NYSE: GM) and Ford Motor Co. (NYSE: F). It’s also worth taking a very close look at Canon Inc. (NYSE: CAJ); while it’s true that this stock is trading at 30 times earnings, which is expensive, remember that Japanese shares historically trade at rather steep valuations.
For the truly adventurous, consider a look at Omron Corp., the world’s leader in fuzzy logic control systems, a business we don’t really have in the West. Alas, in the U.S. market, Omron is quoted only on the pink sheets (OTC: OMRNY). But it does trade actively in both Frankfurt and Tokyo (TYO: 6645).
[Once again we’ve come across a solid overseas stock that U.S. investors can’t easily access. Money Morning newcomers would do well to spend a few minutes checking out two recent research reports: “Global Investing: Has Wall Street Rigged the Game?” and “International Investing: Why U.S. Investors are ‘Boxed Out’ of Big Global Profits.” Both reports are available for downloading directly from the Money Morning web site. And, naturally, both are free of charge.]
Japan: A Play on China
Lastly, whenever you discuss the investment allure of Japan, there’s also the question of China. As we know, China has a bright long-term future. But share prices have been on a torrid run for an awfully long stretch, which I believe substantially elevates risk. Japan is a solid investment in its own right, for all the reasons we’ve articulated [If you’d like additional reasons, you absolutely must check out our 6,000-word investment research report: “Global Investing: The Three Best Investments in Asia Today.” It, too, is available at no cost to subscribers to our free Money Morning global investing news service.] But, for the risk-averse, Japan is a solid indirect play on China (as are the other two markets we detail in our Asia research report). Many of Japan’s major manufacturing companies have established operations in Mainland China, which offers such benefits as lower wages and a close proximity to the headquarters operations of the big firms.
Martin O. Hutchinson is the Chief Global Investing Strategist for Money Morning, as well as an advisory panelist for The Money Map Report. An investment banker with more than 25 years’ experience, Hutchinson has worked on both Wall Street and Fleet Street and is a leading expert on the international financial market.
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