The Long Road: Japan Remains An Enigma

May 02, 2008

With U.S. and European stock markets moving down or sideways, investors are eyeing another major economic superpower: Japan.

 

Despite ongoing political turmoil, the Japanese Nikkei average is rallying, surging nearly 20% since mid-March.

The blue chip exchange has now moved into positive ground for the year. By contrast, most other major developed stock markets around the world remain firmly in the red.

"Japan isn't a top-down story anymore. But it's still the home of many of the world's most competitive global companies," said Darrel Whitten, a former Lehman Brothers research director who now runs Japaninvestor.com.

Improving corporate governance and booming trade has helped boost cash reserves at many Japanese goliaths. Analysts believe that they'll get plenty of opportunities to deploy that war chest in coming years as neighbors such as China, Russia and South Korea continue to grow.

"In world trade, Japan's strategic location can't be ignored," said Tom Hepner, an advisor and portfolio manager at Ruggie Wealth Management in Lake County, Fla. "Its wealth of intellectual capital, well-educated workforce and technologically advanced manufacturing sector puts Japan in a strong position across Asia."

But any payoff from that wealth is likely to be a slow, drawn-out process. The promise of a prolonged resurgence in Japanese equities has come and gone many times before in the past decade. And with GDP growth predications for the next several years hovering around 2% a year, there's concern that if the global economy continues to weaken, Japan will slip into a recession.

"The sentiment is that Japanese stocks have bottomed, but on the upside it's still going to be a bit touch-and-go for awhile," said Whitten, the Tokyo-based analyst. "Institutional investors are concerned that Japan might turn out to be another value trap."

Exporting Is King

Exports remain the backbone of the Japanese economy. While that's a strength in good times, it leaves the country vulnerable when other global leaders slow. "If the U.S. moves into a lengthy recession, it's going to be more difficult for Japan to avoid the same fate than a lot of other major developed economies," said David Cohen, director of Asian forecasting at Action Economics.

Elections later this year could help Japan muddle through any immediate downturn. For now, the country's political system seems paralyzed to enact any major economic reforms. That's key since a stringent immigration policy and aging workforce need stimulus to keep competing at high levels in global markets.

The situation is so bad that politicians can't even decide on whom to appoint as governor of the country's central bank. "It's like President Bush having trouble finding consensus to appoint Ben Bernanke," said Tu Packard, senior economist at Moody's Economy.com. "This is a tremendously embarrassing situation reflecting how much in shambles Japanese politics is right now."

A few rays of hope remain on the horizon, however. Construction activity and bank lending have shown some signs of expansion lately. If fixed-income markets improve, that could provide a big boost to Japan's domestic fortunes. And even though the yen has strengthened against the U.S. dollar, it remains competitive with the euro and major Asian currencies. In fact, the country's interest rates have actually been going up - another positive trend that inflation is present and deflation remains a past nemesis.

"We're fairly optimistic about Japan—if they can get over their political paralysis, the country has strong infrastructure and a very good workforce. This is still a world-class economy with a lot going for it," said Packard.

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