Do you have enough Japan in your portfolio? (Yes, that 20-year bear market Japan)

03/30/2012 8:30 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Does your stock portfolio have enough exposure to Japan?

When’s the last time you heard that question? Your answer is probably measured in decades.

The Japanese stock market, as tracked by the Nikkei 225 index, hit an all-time high—intraday—on December 29, 1989 at 38,957.44 yen. The subsequent low after the bursting of the Japanese asset bubble came on March 10, 2009 at 7054.98 yen. The percentage drop is stunning—82%--but the duration is mindboggling. This bear market went on and on and on for 20 years.

But something unusual—very unusual—happened to Japanese stocks at the end of 2011. In the after-math of the March earthquake and tsunami, the Nikkei retreated to 8605 yen, the lowest level since 2009. Worries about the effects of the destruction on the Japanese economy and fallout from the Euro debt crisis pressured the index lower to a bottom on November 25, 2011 at 8160.

And then the index began to move UP. On March 27, 2012, the Nikkei 225 broke 10,000 yen—climbing to 10,255.15. That’s still 74% below the 1989 high. But it’s the direction that counts.

You’re certainly entitled to ask how long the trend will point up. After all Japan is a country with huge and widely recognized long-term problems of a massive budget deficit and an aging population. I don’t want to pretend that those problems have been fixed or that they don’t count in the long run. But in the short-term—a year or two—I think there’s sound reason to think that the upward trend is sustainable.

Let’s count the whys, okay?

First, the damage from the earthquake and tsunami, the disruption to Japanese businesses from the flooding in Thailand, and the pain inflicted on Japanese exporters as the Euro debt crisis pushed up the value of the safe-haven Japanese yen all mean that Japan’s economy begins 2012 from a very low base. Things don’t have to be great to be markedly better.

 

Second, in a world where developing economies as a whole have an economic growth problem, Japan’s projected GDP growth rate of 2% for 2012—according to the Organization for Economic Cooperation and Development—looks very, very solid.  That 2% growth is the same speed that’s projected for the United States and an awful lot better than the recession projected for Europe.

 

Third, the government spending on earthquake and tsunami reconstruction finally seems to have kicked in. So far the Japanese government has appropriated $220 billion for building new homes and replacing streets and other infrastructure. The reconstruction effort has also unleashed private spending to replace everything from cars to home furnishings.

 

Fourth, I wouldn’t exactly say the Bank of Japan has experienced a conversion to Keynesian stimulus spending but back in February the bank did adopt a 1% target for consumer price inflation. Considering that inflation in Japan is about as rare as the Japanese River Otter (last confirmed sighting 1979), a 1% target is actually amazingly aggressive. In January year-to-year inflation was running at 0.212%. Wages rose 0.3% in January.

 

Fifth, it’s unlikely that this legislation will pass but even its introduction by the Noda government is a sign of real progress. Prime Minister Yoshiko Noda has proposed raising the current 5% consumption tax as a way to reduce the huge government budget deficit. For the fourth year in a row, this year the government’s budget relies more on money raised from new bond sales than it does on tax revenue.

 

If non-Japanese investors are familiar with any Japanese stocks at all after a 20-year-long bear market, they recognize the names of Japanese exporters. With the yen weakening as the dangers of a euro debt crisis (temporarily) receded, shares of exporters have recovered from the beating they took in 2011 when company sales dropped as the yen soared, raising the costs of Japanese goods to customers paying in euros or dollars or yuan.

 

Year to date returns in 2012 for many Japanese exporters have easily beaten the 12.35% gain (as of March 28) for the U.S. Standard & Poor’s 500. Factory automation giant Fanuc (FANUY), for example is up 21.3% for 2012. Farm and industrial equipment maker Kubota (KUB) is up 16.9%. Construction equipment maker Komatsu (KMTUY) is up 21.3%. And Toyota Motor (TM) is up 29.5%.

 

Of course, those returns are relevant only if you have 1) a time machine so you can go back to December 31 and buy the shares or 2) a strong belief that the rest of 2012 will look like the beginning of the year. Here the big issue is the price of the yen. If the euro debt crisis kicks up again with, say, the Greek and French elections in early May producing to new leaders in those countries who want to reopen past deals or, say, with a negative report from EuroZone and International Monetary Fund inspectors on Greece in June, or, say, the need for a rescue package for Spain, then the yen will rally again and Japanese exporters will get hit as hard as they were in 2011. My picks among exporters would be Komatsu and Kubota since both will be big beneficiaries from domestic spending on earthquake and tsunami reconstruction.

 

Japanese exporters aren’t just more familiar names to U.S.-based investors, they’re also easy to buy since most—and all of the above stocks—trade as American Depositary Receipts in New York.

 

Despite the unfamiliarity, though, and any difficulty in buying the shares, I much prefer domestically oriented Japanese companies for the remainder of 2012. (Big online brokerage firms like Fidelity, Schwab, and E*TRADE have all increased their ability to trade for you in overseas markets. It’s worth asking.) They’ll reap the rewards of the relative outperformance of the Japanese economy—in comparison to other developed economies—without the downside exposure to an appreciating yen. In fact, in the case of companies that source their raw materials or products outside of Japan but sell inside the country a rising yen is actually a boost to profit margins.

 

One of my favorite picks in this sector is JS Group (5938.JP in Tokyo or a very thinly traded JSGRY in New York.) The building materials manufacturer owns 40% of the market for toilets in Japan and 50% of the market for window frames. The Tokyo traded shares are up 21.7% in 2012.

 

Or try Rakuten (4755.JP in Tokyo; no U.S. listing), the owner of Rakuten Ichiba, the largest e-commerce site in Japan. The company also has a joint venture with China’s biggest search company Baidu (BIDU) and has recent made acquisitions in Brazil (Rakuten Brazil), Germany (Rakuten Deutschland) and the United Kingdom. In November 2011 Rakuten bought eBook publisher Kobo. The Tokyo shares are up just 2.4% in 2012.

 

And for a big dose of Japanese retailing, look at Seven & I Holding (3382.JP in Tokyo or SVND.US in New York. New York volume runs at about 50,000 shares a day. Tokyo volume about 2 million shares a day.) This holding company, which is the parent of the 7-Eleven chain of convenience stores in Japan (and which completed its purchase of the U.S. 7-Eleven company in 2005), is the fifth largest retailer in the world with 45,000 stores in 100 countries. Back in Japan—the source of 70% of company revenues in 2011--it owns the Ito-Yokado grocery and clothing stores, Denny’s Japan, and the Sogo and Seibu department store chains. Retail sales in Japan rose 1.9% in January after climbing 2.5% in December. The Tokyo shares are up 14.8% in 2012.

That’s by no means the end of the Japanese companies that you can research as you build (or rebuild after 20 years) the Japanese weighting in your portfolio. But it should be enough to get you started. I’ll be giving you more suggestions from Japan as the year goes along. I think this is a story that will run deep into 2012 if not longer.

 

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did own shares of Rakuten as of the end of December. For a full list of the stocks in the fund as of the end of December see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/

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