Why Japan Is Now on a Tear Toward Economic Recovery

May 9th, 2013 by Abby Joseph
NKY: MAXIS Nikkei 225 Index Fund ETF logo
NKY
MAXIS Nikkei 225 Index Fund ETF

Submitted by Abby Joseph at Profit Confidential as part of our contributors program.

Chinese stocks are a disappointment in 2013 and, at this point, are looking to underperform the U.S. stock market for the fourth consecutive year.

But while China sorts out its growth issues, across the East China Sea, Japan has been on a tear. The massive infusion of liquidity into the Japanese monetary system has driven down the yen and, in the process, is leading to an export-led economic recovery.

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The benchmark Nikkei 225 stock market index is up a whopping 36.4% this year, breaking above the 14,000 level for the first time in close to five years.

Take a look at the technical analysis chart below, comparing the movement of the Nikkei 225 index, as indicated by the upward-trending solid green line, and the downward-moving yen.

As the yen weakens, the Japanese stock market rises, Japanese goods become cheaper to buy from foreigners, and this drives up sales of the many Japanese multinationals.

Chart courtesy of www.StockCharts.com

At the same time, the Shanghai Stock Exchange (SSE) Composite Index is down 1.5% and is struggling to convince the world that not all Chinese companies are deceitful. (Read my take in “China in a Holding Pattern, but There Are Opportunities Inside the Great Wall.”)

The chart below shows the movement of the Nikkei 225 stock market, as shown in the candlestick formation, versus the SSE Composite Index, as indicated by the green line.

You’ll notice the outperformance of the Shanghai stock market from 1990 to around 2008, and then the current rally by the Nikkei.

Chart courtesy of www.StockCharts.com

I must admit I was caught off guard by the strength of the Japanese stock market rally this year.

Japan’s Prime Minister Shinzo Abe is going gangbusters, injecting tons of money into the Japanese economy. His goal is $2.4 trillion over the next 10 years.

While I’m not convinced it will work longer-term, it’s clearly working now with the cheaper yen. Again, it’s the case of cheap money fueling the stock market.

The massive spending to try to lever the country out of its multiyear economic coma may work, but a lot will depend on the state of the global economy.

Of course, with the gain comes the pain.

To finance the gross domestic product (GDP) growth, Japan, just like America and many other parts of the world, will add to its national debt. The problem with Japan is that the country’s debt levels are some of the highest in the world, and there’s still the new tranche of stimulus to come. In 2011, Japan’s national debt as a percentage of GDP was a staggering 208.2%, whereas the U.S. was at 102.9% in 2011. (Source: International Monetary Fund, last accessed May 8, 2013.)

The aggressive high-stakes move by Shinzo Abe could be the only way for the country to recover. An extensive period of near-zero interest rates did not work. Since 2005, the country’s interest rate hit its high point of 0.5% in 2007. (Source: “What is the Japanese yen (JPY)?,” GoCurrency.com, last accessed May 7, 2013.)

So while I’m not totally convinced about Japan, you can’t fight the trend in the stock market.

It’s telling the Japanese stock market is as hot as wasabi, and it could rise higher, as long as the Bank of Japan provides cheap money and a weak yen.