Japan back on the equities radar screen

This, we are told, is the Asian century. The emerging economies of the region, led by China, have dramatically altered the economic balance of power within the global economy and helped the developed world limp along in a post financial crisis world.

But Japan, the Asian nation that industrialised almost a century ago, and delivered its own version of the economic miracle from the 1960s through to 1990, for the past 20 years has been plagued by deflation, recession and a dream squandered by a moribund government and poor economic management.

The Japanese market indicator, the Nikkei 225, peaked at around 38,000 in 1990. It now sits at around 10,800. But in the past few months, with the prospect of a new government (or rather the return of an old government), Japanese equities have soared more than 20%. And there are bullish forecasts all around that it is set for a major rally.

Nikkei 225 Index

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Counter intuitive it may be, but if the past five years have taught us anything it is that poorly performing economies often are home to the best-performing equities markets, while the economic engines play host to underperforming markets.

The US, over-indebted and with huge structural problems, has overseen a booming stockmarket in recent years, with the S&P500 close to breaching new records. China’s Shanghai Composite, meanwhile, has languished while Australia – one of the few developed nations not to plunge into recession – has an equities market still 30% below its 2007 peak.

The reason for this conundrum is that weak economies often employ stimulus measures designed to improve international competitiveness and boost corporate earnings, a sure recipe to fire up equity markets.

And with the economy now back in recession, Japan’s new (old) finance minister, Taro Aso, has delivered on an election promise to provide an enormous budget stimulus designed specifically to boost equities, property and exporters.

Like the US, it is a stimulus package that features monetary policy easing, designed to drive the yen lower and lift Japan’s international competitiveness along with enormous investment in infrastructure. There are also plans to switch Japan’s unpopular nuclear reactors back on, despite the devastating impact of the Fukushima meltdown.

Japan’s sluggish economy and persistent deflation for years have left global investors cold. It is no surprise that many global funds managers are significantly underweight when it comes to investing in the world’s third-biggest economy.

It is expected the government’s adrenaline shot, announced this week, will cause a rerating that will force international investors back to Japan.

For retail investors, BlackRock’s iShares has a dedicated Japan Exchange Traded Fund listed on the Australian Securities Exchange, delivering easy access to a broad portfolio.

But for those wishing a more direct route, excitement is building around a raft of Japanese-based global corporations that may be set to benefit from the new stimulus package, announced on Monday by Prime Minister Shinzo Abe, that will inject $US226.5 billion into the economy.

Bank of America Merrill Lynch is extremely bullish on Japan. In a note to investors last week it highlighted a recent study it conducted on 33 of the country’s biggest stocks. Only two were rated as underperformers, while 23 were recommended as buys.

Six of its so-called seven samurai stocks were listed as buys. They included auto manufacturers Honda and Toyota, Japan’s biggest domestic bank Mitsubishi UFG, property group Mitsubishi Estate, Softbank and Shin-Etsu Chemical.

The cheapest buy rated companies included Mitsui and Co, trading at just 7.6 times earnings, and telco NTT, which is priced at just half its book value.

While the study is dominated by references to a falling yen and hence improved international competitiveness, most of the individual recommendations are backed up by unique factors that will aid each company.

The world’s leading auto producer Toyota, for instance, is likely to benefit from reduced capital expenditure and a drive to secure more earnings. Honda, the eighth biggest auto manufacturer, is highlighted because of its recent developments to take fuel efficiency to new levels and solid earnings growth.

Japan’s largest financial conglomerate Mitsubishi UFG has among the world’s most robust balance sheet positions. Merrill Lynch’s chief Japan equity strategist believes its focus is now shifting from strength to growth and increased shareholder returns.

Softbank, one of the three largest Japanese telcos, is also seen to be in a growth phase after its recent acquisition of Sprint, while property developer Mitsubishi Estate, with its extensive real estate holdings near Tokyo station, is tipped to be a major beneficiary of the stimulus given it generally outperforms rivals and has a solid balance sheet.

Shin-Etsu Chemical has the top global share of the PVC and silicon wafer market. While it trades at a relatively high 22 times earnings, it is heavily geared towards North America and will benefit from any lift in the US economy – with a double whammy from a declining yen.

These are just a handful of the stocks recommended in the report. Even before the long-awaited stimulus announcement, it was clear Japan’s markets were giving the plan the thumbs up. The yen slid almost 12% in the weeks since Abe’s landslide victory, and that in turn kicked the Nikkei 225 along.

The bold plan is not without its detractors. It is after all, the 14^th emergency spending plan since 1999. Throughout those programs, bridges were built that no-one needed along with tunnels that went nowhere. And the country already is labouring under a debt burden twice the size of its economy.

Critics insist that the plan is just more of the same and that the country has become addicted to stimulus packages. But the Prime Minister insists that this time it is different, and that waste will no longer be tolerated.

Regardless of the criticism, there is no doubt the program will cut the value of the yen and deliver a serious shot in the arm for Japanese industry. That growth in earnings will help breathe new life into the Nikkei this year.

While an announcement has yet to be made, the new Prime Minister is believed to look favourably upon calls from big business to switch the country’s unpopular nuclear reactors back on.

At $US43 a pound, uranium prices are now around half their levels of early 2008. Like all commodities, uranium was smashed by the general downturn when the financial crisis hit. But the Fukushima disaster sent prices for uranium oxide, which had been recovering through 2010, into a tailspin.

Should Japan embark on a full-scale return to nuclear power, the increased demand clearly will provide a lift to uranium prices. But the negative impact of Fukushima will overhang the market for years. BHP has the world’s biggest deposit at Olympic Dam, Rio Tinto has control of the Ranger Mine through its majority ownership of listed Energy Resources Australia, while Heathgate Resources has the Beverly Mine.

ASX-listed Bannerman Resources has projects in Namibia, Botswana and South Africa, while Paladin has significant operations in Africa and joint ventures in various parts of Australia.

Whether or not this latest fiscal splurge delivers a long-term cure for its economic woes, it is certain at least to transform Japan into the land of the rising equities market in 2013.