KYOTO, Japan – Now that Japan's Nikkei 225 is half the relative price of the S&P 500 – and the cheapest it's been in three decades, investors are flocking to invest in Japan.
But, I don't "buy" it – and you shouldn't, either.
To be sure, there are still world-class businesses here and many Japanese companies are in the best competitive positions they've been in for years. And yet, bluntly speaking, I've never seen a more-nightmarish situation. And here's why:
- Japan's domestic market is a demographic disaster that's characterized by a rapidly aging population and an impossibly low birth rate – neither of which suggest that domestic consumption will improve anytime soon.
- Modern Japan is almost entirely reliant on exports. If exports can't take up the slack caused by the domestic disintegration I've just mentioned, the Nikkei will fall further – as will corporate profits, lending and payrolls. To bridge the gap, Japanese corporations and Japanese companies will have to repatriate assets that are already under pressure abroad, further strengthening the yen at a time when the opposite is actually needed to spark growth. This repatriation is already happening to a small degree; but the real risk is that it becomes a self-perpetuating, self-defeating cycle – instead of the byproduct of the global financial crisis that it's been up to now.
- Nominal gross domestic product (GDP) has not expanded meaningfully in 30 years, and the country's debt as a percentage of GDP is nearly 200% – the highest on the planet. Even Greece – the poster-child for the ill effects of an over-reliance on government debt – has a debt-to-GDP ratio of "only" 115%. (For a look at the countries with the biggest debt-to-GDP ratios – and for some insight on the trouble all that debt can cause – check out the accompanying chart.)
- So far, Japan has been able to finance its debt internally, drawing its huge pool of domestic savings. By 2015, however, this Asian giant could be forced into the external financial markets (just like the United States) as a means of funding this domestic debt. That's when Japan's aging population is projected to begin consuming more assets for retirement than its work force is saving. This will likely double Japan's long-term debt costs, and it will likely cause the stock markets to deflate further in response to interest rates that may actually triple to accommodate the increased risks of external financing. Japan's largely internally financed 10-year note late last week touched 1.16%, the lowest level in 18 months. The comparable externally financed 10-year U.S. ended the week at 3.11%.
- Government reform here has bogged down, the victim of controversy and political mediocrity. Japanese Prime Minister Naoto Kan – elected in early June – is the fifth person to hold that post in the last four years. The story is even worse when it comes to cabinet-level posts: Kan's choice as the new minister of finance – the conservative Yoshihiko Noda – became the ninth finance minister in the past four years. Many Japanese I know have simply turned apathetic, believing that nobody in the Japanese Diet is going to stick around long enough to make any meaningful changes.
- Even now, after 30 years of stagnation, Japanese firms still have some of the highest manufacturing costs on the planet, and remain generally inflexible when it comes to adaptation. Worse still, it's my belief that Japan's "old guard" still doesn't fully understand the competitive threats their country faces from Korea and China – despite the fact that China, and not the United States, is now Japan's single-largest trading partner.
- Prices at supermarket chains have fallen for 13 straight years, according to the Japan Chain Stores Association, and wages have been largely stagnant for decades. Neither is a harbinger of better times to come.
Time to Short Japan?
With such a negative outlook on Japan, you'd think that "shorting" Japan – or even abandoning it altogether – would be the investment strategy that I advocate. But that's not the case. For me, in fact, this is quite problematic.
For one thing, years of living and working in Japan has demonstrated time and again that the Japanese have an admirable, intangible quality they refer to as kesshin – which loosely translates to "quiet resolve," or "determination." Americans might refer to it as "guts," or "true grit," but this quality or spirit actually runs much deeper than that and reflects a Japanese person's innate refusal to give up or give in – no matter the odds.
There's also some reason for hope in the corporate realm. Many Japanese companies – especially the bigger, more-established ventures – have cut their ties to the U.S. market, and have consciously focused their sales efforts on China, even if they don't yet fully understand the nature of the competition they are unleashing in the process. In doing so, these Japanese companies hitched their horse, however hobbled it might be, to a stronger wagon.
Where to Invest Now:
Personally speaking, I'd rather invest in the stronger wagon (China) because the path to profits is more direct. But if you just can't bring yourself to "give up" on Japan – for whatever reason – here's where I suggest that you look for the best potential profit opportunities. Consider:
- Japanese companies that are selling into China's infrastructure boom, which include players in the heavy-machinery, construction-equipment and green-energy. Companies such as Fujitsu Ltd. (OTC ADR: FJTSY), Mitsubishi Corp. (PINK ADR: MSBHY) and Komatsu Ltd. (OTC ADR: KMTUY) have all experienced solid gains thanks to China even though their stock prices do not yet reflect the growing trade there. Those are almost more a "China" story than a "Japan" story.
- Industrial materials suppliers that supply the bigger Japanese companies producing end-use products in the industries I've just mentioned to China. Pay special attention to such areas as industrial ceramics and solar manufacturing.
- And think about Japanese shipping companies. After all, the stuff China needs has to get from 'Point A' to 'Point B.' Most shippers – such as Mitsui O.S.K. Lines Ltd. – have suffered deep losses as a result of the global financial crisis and could logically benefit as the need to move goods north resurfaces. That means you may be able to snap them up at a bargain even if you are early to the party.
If you do decide to invest in Japan, do so with this Japanese proverb in mind: "Ishi no ue ni mo san nen" – which loosely warns us that you have to sit on a rock for three years in order to break it.
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About the Author
Keith Fitz-Gerald has been the Chief Investment Strategist for the Money Morning team since 2007. He's a seasoned market analyst with decades of experience, and a highly accurate track record. Keith regularly travels the world in search of investment opportunities others don't yet see or understand. In addition to heading The Money Map Report, Keith runs High Velocity Profits, which aims to get in, target gains, and get out clean, and he's also the founding editor of Straight Line Profits, a service devoted to revealing the "dark side" of Wall Street... In his weekly Total Wealth, Keith has broken down his 30-plus years of success into three parts: Trends, Risk Assessment, and Tactics – meaning the exact techniques for making money. Sign up is free at totalwealthresearch.com.