Sunrise Is Near for Japan Stocks

01/10/2011 12:01 am EST


Michael Brush

Columnist, MSN Money

The world’s least-loved market is poised for a comeback thanks to low valuations and strong regional growth, writes Michael Brush of MSN Money.

While China may be everyone's favorite emerging-market investment right now, another "emerging" economy could outshine it this year—the economy of China's historical rival, Japan.

Yes, Japan, which was the soaring economic superstar China is now before things unraveled two decades ago. It remains a country that most investors hate, with a laundry list of lingering problems that include an enormous national debt, an aging population, and persistent deflation.

Sure, these problems remain serious, and they're still keeping lots of fund managers out of Japan. But the key is that, by now, these problems are well known and worked into stock prices. Japanese stocks have fallen to the point where, by some measures, they're cheaper now than they have been in 60 years.

But there are also signs Japan is emerging from its long economic winter. And all it's going to take is a little good news for Japanese stocks to reward investors,

"You can go through the list of all the things that have gone wrong in Japan," says Neil Hennessy, of the Hennessy Select SPARX Japan Smaller Companies Fund (SPJSX) and Hennessy Select SPARX Japan Fund (SPXJX), which are already outperforming the markets and most mutual funds. But, he asks, what happens if things there start to go right?

So what exactly could go right for Japan? Let's take a look.

A Little Help from Beijing
Because Japan's economy, like China's, is built on exports, growth in China will create demand for goods from Japanese companies, lifting Japanese stocks over the next year or two. There's an important twist that will make this play out: The Chinese yuan is going to rise in value against the yen.

A stronger yuan amps up Chinese demand for Japanese stuff because it gives Chinese consumers and companies extra buying power. China's emerging middle class wants the same consumer goodies that well-off people around the world want—like the flat-screen TVs and cars that Japanese companies make so well.

Why will the yuan go up in value? First, China is under considerable pressure from the US and other countries to stop artificially suppressing the value of its currency. That's been a deliberate tactic to help China's own exporters over the years. But it hurts domestic competitors in the US and Europe, and those countries are complaining.

Second, Chinese politicians are now worried about inflation, which can spark civil unrest if it gets out of hand. A stronger yuan is a great weapon against domestic inflation.

Lean, Mean Profit Machines
Here's another thing that could go right for Japan: The country's economy may actually post at least a reasonable 2% annual growth over the next two years. Besides demand from China and other hot emerging markets in Asia, Fed actions to boost the US economy will benefit Japan.

Now, 2% growth may not sound like much. But don't forget, it won't take much growth to boost Japanese stocks. One reason is that Japanese companies are lean after so many years of cost-cutting to cope with a strong yen, which hurt their sales abroad.

And, underneath all this, Japanese stocks are just really cheap because of years of neglect. That makes them a great contrarian play—a bet that will pay off once the investing crowd changes its mind and takes an interest in Japan. "Most money managers are underweight Japan," says James Dailey, portfolio manager of the TEAM Asset Strategy Fund (TEAMX), which is placing bets on a rebound in stocks there. "You could get massive money flows in."

[Count Jim Jubak among the contrarians expecting Japanese stocks to rebound. Deborah Owen, on the other hand, warns that and aging population ensures creaky equity returns in the long run. If that’s a turnoff, consider the much more youthful Vietnam, another potential beneficiary from a stronger yuan. Like Japan, that market is currently getting plenty of love—Editor.]

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