Stick with Japan – the quiet recovery will continue

A couple of years ago, the Japanese market had one of its rare moments in the sun.

A burst of rampant quantitative easing (QE – money-printing), and a bold new prime minister (well, second-time round, but who’s counting?) saw the stock market shooting up. Everyone wanted a piece of Japan.

And then everyone got bored, as they do. The economy didn’t turn around overnight. Momentum fizzled. Japan dropped out of the headlines.

Yet the Japanese market has been quietly recovering, and is now back where it was at the start of this year. It’s now not far off a near-seven-year high.

So what’s next?

Take a guess at what’s driving Japan higher

Japanese economic data hasn’t been great this year. The country raised its equivalent of VAT from 5% to 8% earlier this year, which hit consumption for six.

Now I suspect this is nothing to worry about. Conditions are very different to 1997 – the last time the consumption tax was raised. But most people have still been gloomily writing off ‘Abenomics’ as a failure.

So why has the market been recovering pretty well recently?

Like most other financial markets, the surge in Japanese stocks has very little obvious connection to the performance of the ‘real’ economy. Instead, it’s got a lot to do with central bankers and how their actions affect the markets.

Bank of Japan boss Haruhiko Kuroda announced a mammoth QE programme back in 2012. When he did so, a US dollar would have bought you around 80 Japanese yen. At the start of this year, it was more like 100. So QE hammered the value of Japan’s currency. 

But gains in the market and losses in the currency had stalled somewhat, with the yen bouncing around between about 100 and 104. And with Kuroda showing no signs of launching more QE – frankly, it would be hard to justify, such is the scale of the existing programme – the momentum was lost somewhat.

What’s changed now? Well, it’s not so much about the Japanese central bank, as the US Federal Reserve.

The day when QE finally stops at the Fed is drawing ever closer, and there’s no sign that Janet Yellen plans to extend it. Moreover, the big debate now is when US interest rates will rise.

Similarly to the UK, there’s now dissent in the ranks of the rate-setting committee in the US. As the economy gets stronger, it becomes ever harder to justify keeping rates at their current near-zero levels.

In turn, the threat of higher rates has put a rocket under the US dollar. It has strengthened sharply against all of its major currency rivals in the last few months. You can even make the argument that sterling’s recent slide has been more about dollar strength than about fear of Scottish independence, though that has played a role too.

The US dollar’s recent strong run might stop – these things rarely go in straight lines. But given the difference in their central banks’ policies, it’s hard to see the yen strengthening significantly against the dollar in the short to medium term. And one way to benefit from that is to invest in Japanese stocks.

Keep buying Japan

There’s something else that makes me feel a lot more upbeat about the Japanese market. That’s the weakening oil price. As Marcel Theiliant at Capital Economics points out, “Brent hasn’t been as cheap in yen-terms since late last year.”

Given that petrol and related products “account for around 20% of all imports”, this should help cut Japan’s import bill. Meanwhile, the outlook is brightening for its exporters – particularly given the weaker currency.

It’s hard to predict the outlook for the oil price, but in recent weeks it has been plunging – for all the talk of Saudi Arabia ‘not allowing’ prices to go below $100 a barrel, Brent is now below that mark.

Hopefully this will continue – lower energy prices are good news for us all, and the momentum towards alternatives like shale fuel and solar power is strong enough these days that it shouldn’t be stopped entirely simply by cheaper crude.

Of course, on top of all this, Japan is still home to many cheap stocks. In general, Japanese firms have stronger balance sheets than their counterparts in the US and Europe. That puts them in a good position to raise dividend payouts – which they are coming under increasing pressure to do.

You can check out some of the best ways to buy into Japan in this recent story from MoneyWeek magazine. 

• This article is taken from our free daily investment email, Money Morning. Sign up to Money Morning here.

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