While the hot investing money pours into China, Japanese stocks look underpriced despite signs that country's economy is finally picking up. Here are 4 reasons to bet on Japan.
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, probably much more than Chinese stocks will over the next year or two. That's because Chinese stocks look overpriced given that the country -- which just raised interest rates and may need to do more to try to slow its 9% annual economic growth rate -- has been such a favorite hot-money destination.
Will US stocks overtake BRICs in 2011?
A stronger Chinese yuan
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 U.S. 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 U.S. 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, because it cools off foreign demand for Chinese goods. It makes Chinese goods look more expensive, and less desirable, to foreigners. So they buy less, which reduces upward pressure on prices for Chinese goods.
Reasonable growth ahead
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 U.S. 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."
Stealth China plays
Oddly, the cheapness of Japanese stocks is a part of an optical illusion that's tricking investors into missing out on the opportunity. While many investors avoid Japanese companies because of problems in Japan, a lot of these companies are really China plays in disguise, because they export so much to China. The bottom line: That makes them a deceptively cheap way to play China growth.To play a rebound in Japanese stocks, you can buy any of the mutual funds I mention in this column, because they all have exposure to the country. Or you can try your hand at individual companies. I asked the managers of these funds to suggest some of their favorite Japanese stocks buyable on U.S. exchanges.Now, here's a roundup of the main reasons to buy Japanese stocks now, with the stocks to buy to play these reasons.
Reason No. 1: Japanese stocks are unloved and cheap
Contrarian investors like Warren Buffett beat the markets by venturing into disliked sectors. They know that in the ever-changing cycles of the market, out-of-favor areas become popular again sooner or later. The rush of money that comes in as the tide of investor opinion turns can produce great returns. Japanese stocks fit the cheap-and-unloved bill now. Direct comparisons based on price and earnings are tough because of accounting differences in the U.S. and Japan, so let's look at this a different way. U.S. stocks are as cheap as they've been since the early 1950s right now, considering the low levels of inflation and interest rates, says Wells Capital Management strategist James Paulsen. Japanese stocks look even cheaper. Their relative value against U.S. stocks has fallen to its lowest level since the early 1950s, says JPMorgan Chase analyst Hajime Kitano. "We think both absolute and relative valuations are now attractive," he says.Here's another measure that shows how cheap Japanese stocks are. Investors pay $1.80 for a dollar of corporate revenue in the stock markets of Brazil, Russia, India and China, those popular BRIC emerging-market economies. In the Japanese stock market, you pay just 60 cents for a dollar of corporate revenue, Hennessy says.
One example is Itochu (ITOCY, news, msgs). A conglomerate, Itochu gets a very big part of its revenue by selling metals and raw materials in high-growth countries like China. For raw materials, Itochu has similar costs as BHP Billiton (BHP, news, msgs), because it is a joint venture partner with that mining company. But it has a dramatically lower valuation, points out Ned Gray of the Delaware International Value Equity Fund (DEGIX), which owns Itochu. Besides selling raw materials to China, Itochu sells packaged food, textiles, chemicals and industrial components there. In short, it is a China play, but on the cheap.
Note that Itochu, like several of the stocks in this column, trades as a pink sheet stock in the U.S., not trading on a major exchange. While I normally advise extreme caution with such stocks, these are all well-established Japanese companies, so the normal concerns do not apply. This one is thinly traded, however, so buying enough shares to establish a position -- and selling down the road -- may require patience.
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