Japan poised for reappraisal as a value play

Despite all its good points, everyone still hates Japan. But with subprime fallout set to to lead to downturns elsewhere in 2008, the Japanese market could really come into its own.

Japan has "been on the verge of a turnaround for as long as anyone can remember", says Cherry Reynard in Fund Strategy. But this year "marked the end of the road for many investors".

The market has fallen 12% this year, while the unwinding of the yen carry trade has seen the yen rise to 111 against the dollar from 123 this summer, squeezing exporters already exposed to the ailing US consumer. "The bulls will have to wait a little longer in Tokyo," says New York-based Alec Young, equity strategist at S&P Equity Research on Reuters.

But the fall has pushed the yield on equities above that of bonds, which has happened only three times before in ten years, says The Daily Telegraph. When it has, in 1998, 2003 and 2005, the Nikkei 225 rallied 51%, 50% and 52% respectively. "This rising dividend yield will bring Japanese institutional and retail investors back into the domestic markets," Ruth Nash of Invesco Perpetual tells The Daily Telegraph.

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Others still fear that with low interest rates at home, Japanese investors will continue sending their money overseas for several years. But, "a downturn in the world economy may cause a reappraisal of where the value lies", says Simon Somerville, manager of the Jupiter Japan Income fund, in The Mail on Sunday.

While the subprime fallout may lead to downturns elsewhere in the world, in Japan, "households are net savers, companies have good balance sheets and consumption is already low. There is no subprime lending issue". Indeed, "direct subprime exposure is tiny", says The Economist. Official estimates put the banks' combined subprime losses for this financial year at 600bn ($5.5bn), about half of what a single European bank, UBS, wrote off in a day earlier this week.

Yet despite all the good points, everyone still hates Japan, Scott McGlashan, manager of the JOHCM Japan fund, tells Fund Strategy. We are at "the point of maximum pessimism" which is great news for those investing now. A bull market looks like it's around the corner, especially for small- to mid-caps exposed to the domestic economy and sheltered from the dollar downturn.

After an awful year, Hideo Shiozumi's small-cap Legg Mason Japan Fund has rebounded, rising 15% last month alone, while Invesco Perpetual Japanese Smaller Companies, which also focuses on the domestic arena, has also just gone positive. It is up 1.7% in the past three months after a year in which it fell 9.7%.

Promising investment trusts include Perpetual Japanese (PJI) which focuses on retail and transport, and is trading at a 9.8% discount. Another worth a look is Fidelity Japanese Values (FJV), which focuses on small and mid caps, and trades on a discount of 10%.