Last week we learned that Japan’s current account deficit rose to a record level in November. In other words, the country imported more than it exported.
That’s disappointing news for a country that has traditionally been one of the world’s greatest exporters. Especially when it’s trying to break free from a 25-year economic malaise.
A current account deficit is a sign of a country living beyond its means. If the deficit continued to grow, it’s possible that long-term interest rates could soar. That would send the Japanese economy tumbling back into the abyss.
But I’m not worried. I think the Japanese stock market is still set for a good year in 2014. Here’s why…
What’s behind Japan’s big current account deficit?
Japan’s current account deficit in November was ¥593bn ($5.7bn), much larger than the median forecast of ¥369bn.
So why is there a deficit at all? One reason is that Japan has been importing far more energy since nuclear power production was shut down following the Fukushima accident in 2011. Japan’s prime minister, Shinzo Abe, wants to deal with this particular problem by restarting several nuclear power stations, but public opinion in Japan may stop him.
Secondly, the yen has weakened greatly. Although a lower yen should help exporters by making Japanese goods cheaper overseas, it also increases the price of imports in Japan.
However, even if no stations are re-opened, I still think the current account deficit can be reversed. The global economy is picking up, which means that consumers in North America and elsewhere are increasingly likely to take advantage of the cheap yen this year and buy Japanese goods.
What’s more, there are several other reasons to be bullish about Japan.
There’s the government’s new tax-free investment scheme, which is similar to our own Individual Savings Accounts (Isas). Every Japanese adult can save up to a million yen a year into their tax-free account (roughly £6,000).
Breakingviews.com thinks that ten million Japanese could sign up for the accounts.
These accounts could bring in new money worth 3% of the Japanese stock market after five years, not to mention getting domestic investors enthused about their own market once again.
Change is also afoot at Japan’s $2trn Government Pension Investment Fund (GPIF), the world’s largest pension fund. An advisory panel has recommended that a portion of the fund should be shifted from bonds to equities. Even a very modest shift should make a difference here.
Then there’s the Bank of Japan’s continuing commitment to quantitative easing (QE). The Bank has managed to push Japanese inflation up to 1%, but its target is 2% – so the money printing won’t end any time soon.
If there’s one thing we know about QE, it’s that it has proved good news for share prices elsewhere. And as Breakingviews points out, the QE programme is so large in Japan, that the Bank may be forced to move beyond bond purchases simply due to a lack of available bonds to buy. So it’s possible that the Bank could end up buying share-based assets such as exchange-traded funds.
On top of all that, Abenomics (the government’s reform programme) includes some sensible structural changes to Japan’s economy. The government hopes these reforms can boost long-term growth rates. This is the ‘third arrow’ of Abenomics.
The most striking example of structural reform is the decision to enter negotiations to join the Trans-Pacific Partnership free trade area. Nicholas Weindling, manager of the JPMorgan Japanese Trust, calls this “a very significant personal achievement of Prime Minister Abe, who has overcome objections from farmers and other protectionist groups that had prevented his predecessors from entering free trade negotiations”.
How to invest in Japan
If you’re tempted to invest in the Japanese market, the simplest approach is to put your money in low-cost exchange traded fund (ETF) or an index tracker. In December I suggested the Lyxor Japan ETF (LSE: JPNL). It tracks Japan’s Topix index, which includes more companies than the better-known Nikkei, and the annual charges are reasonable at 0.45% a year.
It’s worth bearing in mind that because of currency risk, you could conceivably lose money from an investment in Japan even if the stock market rises. That’s because the yen will probably continue to fall, and if the yen falls by more than the Nikkei rises, you’ll lose out.
You could protect against this by investing in a ‘hedged’ ETF or fund. Of course, bear in mind that this works the other way too – if the yen strengthens and the stock market falls, you’d be fully exposed to any losses in a ‘hedged’ fund, whereas the ‘unhedged’ fund would see stock market losses offset to an extent by currency gains.
If you prefer to go for an actively managed fund, my colleague James Ferguson highlighted some of the best options back in August. You can access the full MoneyWeek archive, including James’s article, by signing up for three free copies of the magazine here.
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