Tags: Martin Hutchinson

In Spite of a Grim Economic Outlook, Japan is a Promising Investment Play

By , Money Morning •

By Martin Hutchinson
Contributing Editor
Money Morning

The investment outlook for Japan is pretty grim right now.

The world's No. 2 economy saw its gross domestic product (GDP) decline by 4% in the first quarter - the equivalent of 15.2% annualized decline, and the worst showing in more than 50 years. Even worse - for anyone who was feeling optimistic about that market, the sharp decline in the prior quarter's GDP was revised upwards, as well.

Japan's embattled prime minister, Taro Aso, who came to office in September just as the downturn was beginning, has introduced several stimulus programs of extra public spending, but nothing seems to work. The stock market is trading lethargically at a level that's about 80% below its 1990 high. And there's an election that has to be held before September.

It's not a pretty picture.

The Japanese are well aware of this; they were not particularly cheerful about their economy even before the present downturn.

There's actually a great Japanese movie that I watched last weekend, called "Bubble Fiction," that illustrates this very well. In the 2007 film, a young girl is down-on-her luck, deeply in debt, and being harassed by yakuza (organized crime) debt collectors. She goes back in time to 1990, in an attempt to stop the policy mistakes that burst the Japanese bubble. Back in 1990, she finds Tokyo a much more fun place, with money everywhere and everyone happy - she even meets her yakuza debt-collector, who is graduating from Tokyo University, and who has lined up a great job with the Long-Term Credit Bank of Japan Ltd. (which went bust in 1998).

Eventually, with the help of a buddy in the Ministry of Finance, she gets to the top guy in the Ministry whose policies caused the crash, and discovers that it is all a plot between him and some rich foreigners, who plan to become billionaires by exploiting the destruction of Japan's economy. She foils the plot, returns to 2007 - and finds it magically changed, in a long burst of prosperity, with no government debt and her Ministry of Finance buddy just appointed prime minister.

So that's the Japanese fantasy - to find some way to undo the malaise of the past 20 years and make the country's economy work properly again. To some extent, Junichiro Koizumi, prime minister from 2001-06, played into that fantasy. He sorted out the banks, started to privatize the Japanese postal system and cut back on wasteful government spending. It seemed to be working, too, as Japan began to enjoy decent - albeit modest - growth again.

Since Koizumi left, however, the governing Liberal Democrat Party (LDP) has abandoned his policies, and current Prime Minister Aso is very much a part of the problem - and not the solution.

Whatever you think of "stimulus" strategies, there can be no question that it is the least likely to be effective in a country that already has a large budget deficit, and that already has public debt that's more than 160% of GDP. If the Japanese economy is currently in a pit, Aso's policies are creating a much deeper bottom.

Just last weekend, the opposition Democratic Party of Japan provided a genuine alternative. Its previous leader, Ichiro Ozawa, was an authoritarian personality who had formerly been a senior member of the LDP, and who had shared many of that party's more unpleasant traditions. He was forced out by an election-funding scandal and the new leader, Yukio Hatoyama, is a milder personality, and a person who appears to offer a genuine alternative.

In his acceptance speech Monday, Hatoyama emphasized "sweeping away wasteful uses of tax money" and "moving from [a] bureaucrat-led to [a] citizen-led government." He also denounced "amakudari" - the "descent-from-heaven" process by which top bureaucrats become powerful private-sector oligarchs.

The DPJ is an amalgam of LDP rebels and moderate members of the old Japan Socialist Party, and its basic philosophy has a plank of opposing "bureaucrat-led protectionism." It is currently leading in the opinion polls, and with Hatoyama as its leader may well appeal to the Japanese longings embodied by "Bubble Fiction."

All of this gives the DPJ a good chance of succeeding in the Diet elections, which must be held by Sept. 6, meaning Hatoyama & Co. would form the next Japanese government.

If Hatoyama does, indeed, clean out the bureaucratic deadwood and cut public spending - while at the same time restraining those on his left who will want more-extensive social programs - he will have an excellent chance of bringing the Japanese economy out of its 20-year downturn and restoring it to its former glorious technology-led growth.

That would cause a huge rebound in the Tokyo stock market, from which we should be poised to profit.

A lot can go wrong. But at current levels, the Nikkei 225 surely cannot go much lower, and Hatoyama now appears to offer a chance of restoring 1990, or at least the early 1980s, when the Japanese market was the best investment in the world. It must be worth a modest investment in the largest Japan ETF, the iShares MSCI Japan index (NYSE: EWJ).

At current levels, EWJ is sporting a Price/Earnings (P/E) ratio of 17, but that's based on earnings in the recession - before the Time Machine takes off!

[Editor's Note: When Slate magazine recently set out to identify the stock-market guru who most correctly predicted the stock-market decline that accompanied the current financial crisis, the respected online publication concluded it was Martin Hutchinson, a veteran international investment banker who is one of Money Morning's top forecasters.

It was no surprise to our readers: After all, Hutchinson warned investors about the evils of credit default swaps six months before the complex derivatives did in insurer American International Group Inc. Then, last fall, Hutchinson "called" the market bottom.

Now Hutchinson has developed a strategy for investors to invest their way to "Permanent Wealth" using high-yielding dividend stocks. This strategy is tailor-made for an unpredictable stock market that's back-dropped by an uncertain economy. Just click here to find out about this strategy - or Hutchinson's new service, The Permanent Wealth Investor.]

News and Related Story Links: