“If ever you needed a convincing argument for active asset allocation, this year has provided it”, says T. Bailey’s Elliott Farley in Investment Week. Last year, the two worst-performing equity regions were America and Japan, but this year that’s been reversed with sterling losses of 12% and 7% respectively. Failures in the US financial sector mean “there’s more fear left in this bear”, says Michael Kahn in Barron’s, but things look far better for Japan.
Japanese banks have stronger balance sheets and much less exposure to US housing-related debt. Household balance sheets are in better shape too. In 2000, household debt in the States, Britain and Japan stood at around 70% of GDP, says The Economist. The Japanese have since cut borrowing to 63% of GDP this year, while US and UK households have “exploded” their debt to nearly 100% of GDP. That means there’s plenty of cash around. Japan’s post office savings bank now holds almost $1,500bn of deposits, while Japanese household assets now total $15,400bn – the biggest liquidity pool in the world. And although the Japanese economy is weak right now, with second-quarter GDP dropping by 0.7%, most of this was down to a surge in inflation.
As commodity prices tumble, “Japan should be among the first [economies] to recover later this year”, says Capital Economics, with “growth returning to the 1.5% trend in 2009 and 2010”. Real household spending, industrial production and housing starts all rose in July, while unemployment ticked down again. And “Japanese companies have amongst the highest profitability, lowest leverage and strongest capitalisation in the developed world”, says Standard Chartered Bank’s Jaspal Bindra in the FT, which ”gives them the balance sheet strength to take advantage of globally depressed asset prices” in making acquisitions.
Yet stocks look cheap. According to Goldman Sachs, around 60% trade below book value, while dividend yields of 1.9% are ahead of the ten-year Japanese government bond of 1.5%. All of which makes Japan look like one of the safer havens for investors right now. But as the yen gets stronger and the global economy weakens, big exporters will feel the pain. So investing in the smaller company sector looks the best idea in the meantime. The JP Morgan Fleming Japanese Smaller Companies Investment Trust (LSE:JPS) is worth a look. It trades on an 11% discount.