Japan is an equity market that intrigues me and a handful of notable value investors such as David Herro, Morningstar’s International Stock Fund Manager of the Decade, and James Hunt of Tocqueville Asset Management.1
Earlier this year, I published a research piece based on historical dividend yield analysis that described what I saw as bullish prospects for Japan’s equity markets based on its relatively low prices.
Japan has been plagued by a perpetual bear market for much of the last 25 years. The last five years have been especially difficult—from the global recession and financial crisis to the earthquake and tsunami of 2011—and were compounded by an ever-rising yen that made Japanese exports less competitive in the global marketplace.
In a research piece entitled “The Sun Also Rises?” Hunt spoke of a “quadruple whammy” of negative factors plaguing Japan, including:
• A slowdown in Japan’s GDP
• A slowdown in China’s GDP (one of Japan’s largest export markets)
• A territorial dispute between China and Japan
• An ever-rising yen
This fourth whammy—the rising yen—is the one I want to focus on in this post. Hunt writes of the yen:
The Yen has defied economics for some time, in part because Japanese investors’ reflexive response in the face of risk is to bring money home and invest it in Yen-denominated assets, and because with domestic deflation, real interest rates in Japan are actually higher than their U.S. counterparts, which are being suppressed by government policy. It has been a fool’s game to guess when the Yen would finally weaken, but economic healing in the West and eventually inflation and rising interest rates here could certainly be a catalyst, as could money printing in Japan. Meanwhile, the strong Yen has forced exporters to become more cost efficient in Japan and to move production to lower cost sites in Asia, which will enhance their profitability in the long run.2
I agree that it has been especially difficult to predict the yen’s performance, to put it mildly. But I believe that the yen is currently the single most important factor driving Japan’s relative performance. As one piece of highly anecdotal evidence, just look at the first quarter of 2012—when the yen weakened 7% and Japan was the best-performing country in the developed world markets.3