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3 key indicators you must know when investing in Japan

James Malthus, Macro Analyst

“Abenomics” has not led to sustained inflation

Although the Bank of Japan’s significant quantitative easing has helped Japanese exporters, the same can’t yet be said for the country’s domestic economy. Inflation excluding food and energy costs is still not in positive territory, which leads me to question if the central bank’s current level of asset purchases is enough to spur the economy. The lack of wage inflation has led to falling consumer confidence, a harbinger of poor future consumption growth.

The BOJ has promised to double the money supply to create inflation

Another sustained uptrend in Japanese stocks will likely require the BOJ to accelerate the money supply growth rate. Although the monetary base has already expanded significantly, the central bank is up against decades of deflation. It’s been six months since the Nikkei peaked back in the spring, and the only catalyst to bring stocks higher seems to be more money printing.

Watch the currency market for changes in the inflation outlook

One of the first places you’ll likely see inflation expectations increase is in the dollar-yen currency pair. If currency traders expect inflation to accelerate, the yen will depreciate against the dollar. The currency pair has been hovering around 100 for the last four months, but for Japanese stocks to see more upside, it will likely need to see a 120 handle.

Japan is a great example of how powerful a force monetary policy can be in the markets. The biggest risk to further upside in Japan is political. To investors in either hedged (DXJ) or unhedged (EWJ) Japanese equities, the risk is whether or not the Abe government and the Bank of Japan have the political will to actually see a higher inflation rate through.

But if they do, Japanese equities could be the stocks to own in 2014.

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