Investing in Japan

Derek Moorehouse - Tue 26 Sep, 2006

...Sino-Japanese trade is set to benefit, and with it investors in Japan...

 
 
- The Yasukuni Shrine in Tokyo honours 14 convicted Japanese war criminals. It also honours 2.5 million victims of various conflicts including those from the Second World War.

- Outgoing Japanese Prime Minister Junichiro Koizumi has enraged China by insisting on making high-profile official visits to the site, stunting the growth of Japanese trade with China in the process.

- Koizumi is likely to be succeeded this month as Prime Minister by Shinzo Abe, who takes a more pragmatic view. Abe won’t say whether he went to the shrine in April and has indicated that if he goes in future, he won’t publicise his visits.

- As a genuine Japanese conservative, Abe has scope to make concessions to China that would be unthinkable for a reformer such as Koizumi. Sino-Japanese trade is set to benefit, and with it the prospects for investors in Japan.

- Even Emperor Hirohito, who died in 1989, stopped visiting Yasukuni because of its honouring of war criminals. China and South Korea have both refused to hold leaders’ summits with Koizumi because of the issue. They’ve given up trying to cultivate ties with him and are focusing their lobbying efforts on Abe, who has said that better ties with China and South Korea are a priority.

- Analysts say that Abe’s unquestioned conservative credentials place him in the mould of Richard Nixon who, as US President, made a ground-breaking visit to Beijing in 1972. Merrill Lynch’s chief economist in Japan predicts a Sino-Japanese summit within six months.

- These are very encouraging signs for investors willing to consider Japan. The country has finally been able to achieve a healthy and sustainable economic recovery. The current expansion will become Japan’s longest since World War Two, assuming it continues to the end of November.

- Job vacancies recently touched their highest level for 14 years, and among G7 countries, only the UK has a lower unemployment rate. A business confidence survey in June indicated Japan’s severest labour shortage since 1992. Large companies plan to lift capital investment by 11.6% in 2006, the largest increase for 16 years.

- The recovery has been achieved even as the potential of Sino-Japanese trading relationships has remained under-explored for political reasons. During the 1980s and 1990s Japan was the clear leader in terms of China-bound trade and investment.

- Yet the re-emergence of the old war-related distrust meant that the European Union and the US had overtaken Japan by 2004. Japan accounted for 20% of China’s overseas trade in 1994, but by last year this had slumped to 13%. Recent relations between the countries have been described as the coldest since diplomatic ties were normalised in 1972. South Korea now invests more in China than Japan does. Under Abe, all that looks set to change.

- Interest rate increases in the US and Europe have meant that investors keen to avoid Japan’s rock-bottom rates have had more and more reason to invest their money elsewhere. That has led to a period of yen weakness, creating a good entry point for investors who want to hold Japanese equities, rather than bonds. Sterling has strengthened 9% against the yen this year, while the euro has recently reached record highs against the currency.

- In July, the Bank of Japan increased interest rates for the first time in almost six years and said that deflation is finally set to end. The world’s other major central banks may be near the end of their cycle of tightening. That means that the reward in yield for avoiding the yen is probably now near its peak, and should start to narrow over the coming year. The Economist Intelligence Unit predicts that the yen will rise against the dollar this year and next as the Federal Reserve stops lifting rates while the Bank of Japan keeps going.

- In the medium term, the yen also stands to benefit from the gradual process whereby the Chinese yuan is allowed to appreciate to a market-determined value. This increases the value of Sino-Japanese trade, estimated to top $200bn this year; the yen advanced when China dropped the yuan’s peg against the dollar in July 2005.

- Citigroup, the world’s third largest currency trader, forecasts that the yen will climb to 104 against the dollar in a year from its current level of 116. Yen appreciation would also increase the net asset values of sterling-denominated investment trusts that hold Japanese equities.

- The Economist Intelligence Unit predicts China’s economic growth to exceed 10% in 2006 and 2007. The rise of China means that Japan, which used to be much more dependent on the health of the US economy, now has two major external supports. That improves its prospects for sustainable growth in the long term.

- Given his political pragmatism, Abe is justified in supposing he can do better than his predecessor in terms of the economy, and will reportedly target annual growth of 3% as opposed to the current official target of 2.2%. In combination with yen weakness, that creates a good entry point for investing in Japan...

 
Regards,

Derek Moorhouse
for The Daily Reckoning