Each week, a professional investor tells MoneyWeek where he'd put his money now. This week:John Millar, manager of the Martin Currie Pacific Investment Trust.
Over the last decade or so the sun appears to have set on Japan. It's struggled with a moribund economy, an ageing population and stagnant stock market, even as other Asian Tigers have roared ahead. So is Japan destined to be permanently out of step with the rest of Asia? Or (given its similarities to, and increasing competition with, South Korea and Taiwan) will Japan realign itself and the performance of its stock market with its Asian peers?
The first thing to note is that both Japan (up 19.2% in sterling terms) and Asia ex-Japan (up 20%) outperformed the MSCI World index (up 15.9%) over 2010. So, after a decade of lacklustre performance, the Japanese market actually proved a remarkably good investment for UK-based investors last year. But what explains this more encouraging performance? And, more importantly, will it continue?
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The answer to the first question lies in a major shift in Japan's macro-economic policy. In October, the Bank of Japan launched a programme of 'comprehensive easing' asset purchases that amount to a return to full-scale quantitative easing for the first time since 2003.
As Japan's central bank has come under increasing political pressure to tackle the country's deflation problem, it appears to have been spurred into action by threats to its independence. The move follows the Ministry of Finance's September intervention in the currency markets, which appears to have prevented a stubbornly high yen from strengthening further.
Together, these actions have created a much more favourable environment for Japanese equities, which produced most of their full-year return in the final quarter.
But what lies ahead? Despite the strength of the yen, Japanese corporate profits have remained strong. That's because massive cost-cutting initiatives, undertaken in the wake of the global financial crisis, have lowered companies' break-even points by as much as 13% and helped boost profits in the process. Indeed, many Japanese firms now expect to exceed previous peak profits over the next couple of years.
More importantly, stockmarket valuations are cheap relative to the prospects for earnings growth. In most cases, the prices of Japanese stocks have failed to keep up with earnings. And with signs that the prolonged period of yen strength is coming to an end, Japan's manufacturers should be able to improve earnings further still. Finally, although global inflation poses risks to high-flying stockmarkets elsewhere in Asia, the Japanese economy has been saddled with deflation for 15 years. The prospect of inflation should prompt domestic investors to sell bonds in favour of equities. Meanwhile, inflows of overseas capital have turned net positive.
So there's a clear case for pan-Asian investors to increase their exposure to Japan. Attractive stocks include Suzuki Motor (TYO: 7269), which is exposed to growing demand for cars in India through its subsidiary Maruti Suzuki. Another compelling stock is oil and gas explorer Inpex (TYO: 1605), which is very cheap despite some big impending gas contracts from its Australian Ichthys project. Meanwhile, Nintendo (TYO: 7974) is poised to launch a new 3D version of its DS console, which will be followed by a wave of high-margin software titles.
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