While U.S. stocks are having a stellar year, Japanese stocks are doing even better. Year-to-date, the Nikkei 225 is up nearly 40%. Even after adjusting for a falling yen, Japanese stocks are up around 23%.
I continue to believe that Japan offers more upside potential in the next three months to six months, and I see near-term opportunities in the market, particularly if investors can hedge out the foreign currency exposure. The case for Japan relies on four arguments:
- Growth. For investors who still view Japan as the perpetual laggard, it’s worth pointing out that in the first half of 2013 the Japanese economy grew by around 4%, twice the growth rate of the U.S. economy. Expectations for the back half of 2013 suggest an economy likely to slow to around 3% growth, still beating other developed markets. In addition, after years of entrenched deflation, Japanese prices are finally starting to rise, which is helping nominal growth as well as corporate profits.
- Expansive Monetary Policy. A large part of the reason for Japan’s turnaround is the Bank of Japan (BOJ). The new governor of the BOJ embarked on an aggressive asset purchase program of 7 trillion yen a month. Adjusted for the size of the Japanese economy, this is much more aggressive than the Federal Reserve (Fed)’s current quantitative easing (QE) program. Just as important, while the Fed is likely to start to transition out of its asset purchase program in 2014, the BOJ will likely continue to provide ultra-loose monetary conditions for at least another couple of years.
- Valuation. On both a price-to-book measure as well as a cyclically adjusted price-to-earnings ratio comparison, Japan continues to look cheap compared to the United States. Currently, the Nikkei trades at 1.5x book value, a 40% discount to U.S. stocks. While there are good reasons why Japan should trade at a discount, the size of the current differential suggests Japan is the better bargain.
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