Why Is Japan Beating The Rest Of The World?

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Posted: May 10, 2018 12:46 PM
Why Is Japan Beating The Rest Of The World?

I mentioned in a previous column that Japan has been performing well lately. This is not the story we're used to reading. I also mentioned that the index I work on, VIEQX, held Japan as a top weighting as of the last rebalance in late January. Why? What did our models see?

First, let's look at the overall score. This data looks at a combination of three models: one that looks to increase probability of performing well in the short run, one that looks to increase probability of performing well in the long run, and one that looks to limit the downside in the event of a sudden risk spike. Those have been combined to create these scores:

As you see, Japan is among the top in terms of score. Let's break that down a bit to get a better idea of what's going on. Where Japan really shines is in resiliency.

But Japan is not equally shiny in all categories. It's great on diversification -- it’s a whole economy in a microcosm, not like some developing countries which are one-trick wonders, dependent on a small grouping of (usually state-owned) enterprises which all churn out the same one or two commodities (like Russia with oil and gas). Japan’s got good rule of law. Low corruption. Smart, hard-working, educated workers. It's a low-inflation economy (lower than its Keynesian planners would like). Demographically, it is disastrous: It sells more adult diapers than baby diapers. A very low birth rate is economic death in the long run, but a country can run an economy without babies pretty well (not counting toy makers) for a while.

Debt is a big long-term problem. Japan is brittle because of debt. Eventually there will likely be a reckoning, a horrible one, with a full-blown debt crisis and a nation filled with nursing homes unable to work its way out of it.

When we change allocation to a company, it's usually the result of a change in valuation, and only sometimes a shift in policy. As you see below, the policy shift has been fairly negative. That's a mix of some slight improvements in growth policy under Shinzo Abe (especially in resisting the global shift towards protectionism), but mostly a matter of interest rate suppression. Japan cut bond yields a lot last year, which means that they have less room to cut them again this year. They've spent most of their ammo.

So why buy Japanese stocks? Answer: Because they are on sale.

Japanese profits grew over 3% from the end of June to the end of December. Even more importantly, forecasted earnings for this year went up almost 7%. That’s the key. Investment is about the future.

Japan is no shining star for ultra-long-term growth. It's more like a stable (for now) earnings delivery system, which you buy when it's on sale and sell when it's overbought.