Can Japan’s run of good news continue? Yes – here’s why

Japan was one of the fastest-growing developed economies in the world in the first three months of the year.

Now there's a sentence you don't get to write very often.

And the even better news is that growth came in ahead of everyone's expectations. It suggests that the grand plan to reflate the Japanese economy is working.

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But can the good news continue?

We very much think so. Here's why

Abenomics is about more than just a policy change

Abenomics' the policy of reflation pursued by Japanese prime minister Shinzo Abe seems to be working.

There's still plenty of nay-saying out there about Japan. That's only to be expected this is a market coming out of more than two decades in the wilderness. But it's also extremely encouraging. As I've said before, the more scepticism there is, the more potential converts there are to a more bullish state of mind.

In the first quarter of the year, the Japanese economy grew by 0.9%, or 3.5% annualised. That was well above the 0.7% quarterly gain expected. Exports grew by 3.8% in the quarter, while consumer spending rose by 0.9%.

The shift in consumer spending is particularly striking. As Masaaki Kanno at JP Morgan pointed out to the FT, consumer spending is usually last to recover. "In the past, recovery was driven by an increase in exports, which led to a rise in cap ex [investment by companies], and eventually consumption followed with a time lag."

This suggests that if nothing else, Japanese consumers either believe that inflation is coming, so they should spend now, or they are convinced by the booming stock market that the good times are back.

They might also just possibly be anticipating better times in the job market. As Peter Warburton of Halkin Services points out, since April, companies have been awarded tax breaks to the value of 10% of the value of pay increases of 5% or more. "Abe's strategy is to transfer the profits windfall obtained through yen depreciation to the wage bill."

The shift in psychology is an important part of Abenomics, says Warburton. This is more than just a change of government or policy. "This is about the reassertion of Japan's place in the world." But can it continue?

The answer is yes. And one of the main reasons is because Japan has a very powerful ally behind it the US. America has implicitly backed Japan's reflation policy, even although a weakening yen is not necessarily good news for US exporters. There are a couple of very sensible reasons for this.

One, which we've touched on in the past, is the fact that the US needs a strong Japan to act as an ally and counterweight to China in the region. A potentially far-reaching trade deal the Trans-Pacific Partnership, which strengthens trading ties between the US and Japan, Australia and Vietnam among several others is just one aspect of this.

But a second factor is that if the Federal Reserve ever wants to ease up on the business of money printing, it's helpful to have someone else in the world providing an unlimited supply of liquidity to pump up stock markets.

American backing isn't the only reason why Abenomics looks set to succeed. But it's certainly a great help.

How to invest in Japan

Markets of course, have gone wild recently. A correction could come at any moment. At the same time, you could have said much the same at any time since the Nikkei passed 13,000.

I'm not saying you should lob caution to the winds, but I don't think long-term investors will regret buying into Japan now. As I said the last time, if you're worried about getting your timing wrong, then you can avoid the pain of cognitive dissonance by simply drip-feeding money in on a regular basis.

We've mentioned several Japan funds in MoneyWeek magazine in the past. But in the latest issue, my colleague, exchange-traded fund (ETF) specialist Paul Amery, looks at ETFs that reflect the performance of both the wider index, and the smaller companies sector.

Paul also looks at some ETFs that hedge your yen exposure. One thing to bear in mind about this is that if you do choose to hedge the yen, you are making a more concentrated bet that Japan's rise will continue. Buying Japan in sterling offers something of a safety valve if stocks fall, the currency is likely to rise, offsetting your losses to an extent.

We look at some of the wider implications of Japan's devaluation including why it may be bad news for China in this week's issue of MoneyWeek magazine. If you're not already a subscriber, subscribe to MoneyWeek magazine.

This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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