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Japan’s fixed investment is recovering but has a long way to go

Marc Wiersum, MBA

The Bank of Japan Tankan supports a 2014 Japanese equity rally (Part 2 of 10)

(Continued from Part 1)

Investment is back to 2005 levels

The below graph reflects the ongoing improvement in Japan’s fixed investment environment. As the Japanese yen had appreciated from 140 to the U.S. dollar to 75 to the U.S. dollar from 1998 to 2011, global fixed investment capital flocked to China, leaving Japan in the dust. However, as the Japanese yen has finally begun to depreciate aggressively against the U.S. dollar—and the dollar-pegged Chinese yuan—things could be changing. This article considers the prospects for ongoing and improved fixed investment recovery in Japan, which would be a great positive for Japanese equity investors.

A strengthening Chinese yuan takes pressure off the yen

The Japanese yen has depreciated roughly 30% against the U.S. Dollar and Chinese yuan since late 2012, and corporate profits have begun to grow rapidly. Plus, the slack production capacity in Japan is out of the danger zone post-2008, and headed back to the 2007 levels. Should this trend continue, we might expect to see fixed investment data, as noted above, move back to the levels seen during the 2002–2006 period of expansion, when the Nikkei stood at 18,000—roughly 30% higher than the Nikkei is today.

To see how Japan’s production capacity has tightened to 2005 levels, supporting equity markets, please see the next article in this series.

Japan’s equity outlook

As 2014 progresses, investors could see a continued outperformance of the Wisdom Tree Japan Hedged (DXJ) and the iShares MSCI Japan ETF (EWJ) versus China’s iShares FTSE China 25 Index Fund (FXI) and Korea’s iShares MSCI South Korea Capped Index Fund (EWY). Plus, as Japan pursues unprecedented monetary expansion and the U.S. Fed tapers its bond purchases, Japanese equities could also outperform broad U.S. equity indices, as reflected in the State Street Global Advisors S&P 500 SPDR (SPY), State Street Global Advisors Dow Jones Index SPDR (DIA), and Blackrock iShares S&P 500 Index (IVV).

Continue to Part 3

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