How to Judiciously Play a Long-Overdue Upturn in the Japanese Economy

To say the Japanese stock market has not gone anywhere for a long time would be too kind. It’s been a losing proposition, as deflation amid barely-there economic growth hasn’t been a recipe for rising asset prices.

^N225 Chart

^N225 data by YCharts

Yet for about just as long you could always find value investors sniffing around, insisting that some companies were too cheap to ignore. It is indeed cheap. Major Japan stock indexes trade at about book value right now -- a range they’ve stuck around for years --compared to the 2.2x book value for the S&P 500 stock index. Only thing is, cheap can stay cheap for a very long time. See the chart above if you need a reminder.

But this past weekend may have marked an important turning point for Japanese stocks. A new government was voted into power, largely on the basis of its promise to stop futzing around and get the economy going. A prime target: weakening the yen, which has remained stubbornly strong against other major currencies.

US Dollar to Japanese Yen Exchange Rate Chart

US Dollar to Japanese Yen Exchange Rate data by YCharts

The prospect of a weaker yen is setting hearts aflutter in the C-suite’s of Japan’s global manufacturers who have been having a very tough time selling their wares with such an uncompetitive currency.

The return of the Liberal Democrat party to power was expected; and the stock market seems to have been anticipating the welcome shift in economic policy. Over the past month, the Nikkei Index has risen 7.4%, compared to a 4.3% gain for the S&P 500. Maybe -- and it’s still just a maybe -- this is the long-awaited pivot point.

Given that one of the prime catalysts for an extended market rebound will be a weakening yen, a hedged position for an export-heavy portfolio is the way to go. (Doubleline’s Jeff Gundlach has an even more aggressive idea. He says his strongest investment idea -- amid much defensiveness -- is to short the yen and go long the Japanese stock market.)

And hey, there’s an ETF for that: The WisdomTree Japan Hedged Equity Fund (DXJ). Among the ETF’s largest holdings are Canon (CAJ) which derives 81% of its revenue from outside Japan, followed by the likely automotive suspects: Honda Motor (HMC) with 81% of revenue from foreign operations, Nissan Motors at 79%,and Toyota Motor (TM) with 70% of revenue coming from outside Japan.

CAJ Chart

CAJ data by YCharts

Not exactly on fire, eh? But zoom in on the past month and something could be brewing. Canon gained more than 13%, Honda is up more than 8% and Toyota gained 7% during a stretch when the U.S. market rose 4.3%. Only Nissan lagged with “just” a 3.7% increase for the month.

With a PE ratio of about 10, Honda Motors is the cheapest of the group. Both Honda and Canon are currently rated attractive by YCharts.

Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at editor@ycharts.com.

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