Japanese stocks and corresponding exchange-traded funds like the iShares MSCI Japan ETF (NYSEARCA:EWJ) and the WisdomTree Japan Hedged Equity Fund (NYSEARCA:DXJ) had a great second-half of last year and haven’t slowed down in 2015.
How much longer can this outperformance go on?
After all, the Nikkei 225 is up 20% in the last six months alone, and it’s not like the Japanese economy is healthy. Indeed, Japan barely pulled out of recession at the end of last year.
Japan’s gross domestic product grew at a below-forecast 2.2% annualized rate in the final quarter of last year after two straight quarters of contraction. On a quarter-to-quarter basis, GDP growth was just 0.6%.
Heck, Japan’s economy has contracted in six of the last 12 quarters, and the average growth forecast for all of 2015 stands at just 1.2%. After peaking in the first half of 2014, corporate profits are projected to continue to decline through the end of the year.
Even policymakers determined to re-inflate Japan’s moribund economy can’t be entirely trusted. Japan’s policy of quantitative easing on steroids was doing a pretty good job before an ill-timed hike in the country’s sales tax pushed the economy into recession last year.
Yet, despite that “what were they thinking?” episode, extraordinary monetary policy is simply too good for equities to ignore. Much of the U.S. stock market’s incredible bull market has been fueled by bargain-basement interest rates and cheap credit, and now the Japanese stock market could be ready for its own turn. Russ Koesterich, chief investment strategist at BlackRock, writes:
“Recently, Japanese companies have been stealing a page from their U.S. counterparts: taking advantage of underlevered balance sheets and cheap interest rates to buy back shares. Given this trend, coupled with the palliative effect of a lower currency, Japanese shares appear interesting, despite a spectacular 2013 and a solid second half in 2014.”
Japanese Stocks on Sale?
Another key to the bull case for Japanese stocks this year: GDP forecasts might just surprise to the upside this year. The stronger dollar is doing wonders for Japanese exports. Strong manufacturing data is getting a lift from solid growth in core machine orders.
It’s also no small matter that Japanese stocks are one of the few places in the world where equities still look cheap — and that is doubly true for the developed world. Indeed, Japanese stocks are the only developed market where equities trade below their own long-term averages on both a trailing and forward earnings basis.
The valuation on Japanese stocks is even more favorable by other metrics. Here’s Koesterich again:
“Japanese equities remain inexpensive based on most measures, specifically price-to-book…Even after the 100%+ rally of the past 21⁄2 years, based on price-to-book, Japanese stocks trade at a 35% discount to developed countries, large even by the standards of the past 20 years.”
As good as the bull case on Japanese stocks might sound, keep in mind that the end to the longest bear market in history has been foretold many times over the last 20 years. True, EWJ and DXJ could very well have lots of upside ahead, but you’d do well to ratchet up those stop-loss orders along the way.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
