A powerful new bull market in stocks is just beginning to take off. Yet virtually no one you know – including seasoned investors – is taking advantage of it. No, I’m not talking about the U.S. market, which is in the midst of its own three-and-a-half-year upswing. I’m talking about Japan. The Nikkei 225 – Japan’s equivalent of our S&P 500 – has surged 12% over the last eight weeks. In my view, this is just the beginning of a powerful move higher. Yet almost no one is on board. And it’s not hard to see why…
In 1989, the Nikkei 225 – Japan’s equivalent of the S&P 500 – hit an all-time high near 40,000. Today, 24 years later, it languishes near 10,500, almost 75% lower. In other words, the Nikkei 225 would have to nearly quadruple just to get back where it was in 1989.
What happened to drive Japan’s market down so far for so long? Let’s start with a late-80s real estate bubble that made our own recent housing mania look bush league. Property prices were so inflated that at one point the grounds of the Tokyo Imperial Palace were valued higher than all the real estate in the state of California. Now that’s crazy…
You can guess what happened to the banks that loaned money using real estate like this as collateral. Japan suffered the mother of all banking crises. And the resulting 20-year deflation led to that country’s two “lost decades,” virtually no economic growth and sharply contracting stock prices.
To top it off, Tokyo may be even more politically dysfunctional than Washington. Government spending has been even more profligate. Public debt as a percentage of GDP is the developed world’s highest at more than 200%. And powerful vested interests have blocked reform.
But voters have finally said “enough is enough” and change appears to finally be on the way with the election of Japan’s new Prime Minister Shinzo Abe, who served a previous term in 2006 to 2007.
Abe has pledged to spark growth out of the world’s third-largest economy. He has created a cabinet post and a special headquarters team devoted to juicing things up with everything from tax reform to health care deregulation. He also plans to root out a mass of old rules and customs that stifle business.
We’re all skeptical of politicians’ promises, of course, but the recent surge in the Tokyo market reflects the consensus that this time the change is real. Yet Japanese stocks remain among the least expensive and most unloved in the world. If the Nikkei 225 doubled tomorrow, it would still be cheaper than the S&P 500 on a price-to-book basis. Virtually no one is enthusiastic about the Tokyo market.
Yet history shows that when it enters a bull run, it can look a bit like the Silver Spurs Rodeo. For example, if you invested $10,000 in the S&P 500 in 1970 and reinvested dividends, two decades later it would have been worth over $76,000. Not bad. But the same amount invested in the Nikkei 225 would have turned into more than $600,000.
In recent years, the cost of doing business in Japan has decreased dramatically. Land prices, office rents and labor costs have come way down. So have taxes and tariffs. And there have been serious banking reforms.
The nation also sits on a mountain of personal financial assets – more than $100,000 for every man, woman and child. After more than two decades of negative stock market returns, most of this capital is sitting in low-yielding bank deposits. Even a small fraction of these assets returning to the equity market could give it a serious jolt.
Global equity managers are also seriously underweight Japan. Many of them have managed to beat their benchmarks by ignoring this market. Yet if the upsurge in Tokyo continues, they will be forced to play catch-up and rapidly pour billions into this market. This could well be the catalyst for the next leg up.
How do you play a resurgent Japanese stock market? There are dozens of Japanese ADRs traded in the U.S., plenty of (mostly unknown) Japanese mutual funds and more than a few ETFs. Many of them represent exceptional value.
And when a smart investor sees exceptional value, he jumps.
Related: iShares MSCI Japan Index (NYSEARCA:EWJ), ProShares Ultra MSCI Japan (NYSEARCA:EZJ), ISHARES PLC ISHARES MSCI JAPAN (LON:IJPN), WisdomTree Japan Hedged Equity Fund (NYSEARCA:DXJ)