Investors should stick with Japanese stocks

Japanese stocks may have taken a knock, but the market has further to go.

"The Japanese economy stumbles easily," says Economist.com. GDP shrank by 0.4% in the second quarter, with consumption (worth 60% of Japan's economy) posting a small decline the first time that household spending has fallen since last year's recession.

"It seems to be taking longer than expected for the improvement in incomes and fall in oil prices to trigger growth in consumer spending," says Bank of America Merrill Lynch (BAML).

But another recession appears unlikely. Industrial production and employment data suggest that "strong domestic corporate earnings" are still driving company investment and jobs growth. The main worry for now is China's yuan devaluation. China is Japan's second-largest export market, accounting for 18.3% of foreign sales. But this figure is worth just 2.7% of GDP, as overall exports make up just 16% of national income.

The upshot, reckons BAML, is that a 5%-10% yuan depreciation would only shave around 0.1%-0.2% off Japanese GDP.Moreover, an aide to Prime Minister Shinzo Abe has warned that Japan can offset a sliding yuan by printing more money itself, weakening the yen.

The Bank of Japan may have to step up the pace of quantitative easing in the autumn anyway, as inflation is still far below its 2% target, says Capital Economics.

A weaker currency implies a further boost to the earnings of Japan's exporters, who dominate the stockmarket. Japanese stocks, already trading at around 15-year highs, have further to go.

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