Japanese Stocks Continue To Outperform

By Aaron Levitt | December 03, 2013 AAA

After years of being called “dead money”, investors in Japanese equities have been finally vindicated over the last year. After a string of policies designed to truly pull Japan’s economy out of the deflationary funk, the Nikkei- Japan’s main stock market index- has surged by 50.7% this year. That’s nearly double the performance of the Dow Jones Industrial Average (NYSE:DIA).

And given that torrid pace of gains this year, some investors have wondered if the rally in Japanese equities is bit long in the tooth. However, for investors several factors should help keep the party in Japan going throughout 2014. That means there’s still time to add a dose of the Japan to portfolio.

Japan Still Rising

Already one of the best performing equity markets this year, the land of the rising sun may just keep on rising in the New Year according to analysts. Bullish tailwinds continue to support higher prices for Japanese stocks.

The key for Japan’s equity markets has been the continued supportive policies of Abenomics. The landslide election of Shinzo Abe as Japan’s prime minister changed everything and the dynamic new policies- such as inflation targeting and stimulus measures- to get the Asian nation back on track seem to be working. After five years’ worth of a negative consumer price index (CPI) measures- indicating deflation- Japan has finally had some measures of inflation. This October, Japan’s CPI showed a year-over-year reading of 0.3%. While that may not seem huge, it was the biggest jump since 1998. More importantly, it showed that Abenomics may finally be working to turn the tide.

Given the recent success, analysts expect that Abe’s quantitative and qualitative easing, stimulus measures and other reforms to continue throughout 2014. Goldman Sach’s (NYSE:GS) estimates that Japan’s market will gain about 16% in 2014 on the back of Abe’s continued stimulus, while Credit Suisse (NYSE:CS) predicts that Japan’s heavy machinery and other value-added high-tech goods exporters will see huge gains as the nation will be a major beneficiary of the expanding global economy. The yen has continued to weaken and that benefits firms -like Canon (NYSE:CAJ) and Kyocera (NYSE:KYO) –who thrive of exports for profits.

Meanwhile, despite rising by so much this year, Japanese stocks are still dirt cheap.

Research conducted by Barclay’s (NYSE:BCS) shows that both the cyclically-adjusted price-to-earnings (P/E) ratio, along with forward P/E metrics are still in the lower end of their historical 25-year range. At the same time, the iShares S&P/TOPIX 150 Index (NYSE:ITF) price-to-book ratio is also low.

That presents a bullish outlook of Japan’s equities.

Time To Bet On Japan

With Japan about to cast off its “dead money” moniker, investors may want bet on the nation in 2014. Both the iShares MSCI Japan Index (NYSE:EWJ) and SPDR Russell/Nomura PRIME Japan (NYSE:JPP) have become the most popular ways to play Japan, the fallen yen can and will reduce returns in these funds. Barclay’s recommends shorting the currency via a fund like ProShares UltraShort Yen (NYSE:YCS).

Or investors can use the new WisdomTree Japan Hedged Equity (NYSE:DXJ).

The fund uses an innovative hedging strategy to essentially take the yen out of the equation, so investors just get the stock returns. That provides “pure” exposure to Japan’s leaders like Mitsubishi UFJ Financial (NYSE:MTU). The fund has surged over 50% this year and should continue to do so as Abe’s policies work their magic in Japan.

Finally, the last frontier for investors in Japan could be the nation’s small-caps. As deflation has persisted, these domestic players been largely ignored by the investing public. As Abenomics trickles down the economy. The SPDR Russell/Nomura Small Cap Japan (NYSE:JSC) tracks 466 different Japanese small-caps and can be had for a P/E of 15.

The Bottom Line

While Japan has been called dead money for years, the past year has removed that moniker perhaps for good. With supportive policies in place, the gains for the nation’s equities could continue into 2014. For investors, the time could be right to place their bets on a rising Japan.

Disclosure - At the time of writing, the author did not own shares of any company mentioned in this article.

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