3 Investment Ideas to Ride a Japanese Rebound, EWJ, JOF, and KUB

As reflected by the precipitous slide in the Nikkei Index, Japanese stocks have been out of favor for more than two decades. Following the disastrous earthquake of March 11, this has changed, however.  In a cover story on March 19^th issue, Barron’s prompted investors to buy Japanese stocks now, to take advantage of the country’s reconstruction boom, while a week later, mutual funds and ETFs investing in Japanese equities reported an $1.5 billion inflow.  Is this exuberance about Japanese stocks rational or irrational?

The answer to this question depends on the comparisons made between the March 11^th earthquake and previous disasters. When comparisons are made with the earthquake of 1923 that leveled most of Tokyo, and the disaster of the Second World War that left most Japanese cities leveled this exuberance is rational, as the disasters changed economic fundaments, especially policy. Both disasters prompted policy makers to ease monetary and fiscal conditions that fueled an expansion in the aggregate demand, especially a construction boom that boosted equity prices, especially shares of companies involved directly or indirectly in reconstruction.

When comparisons are made with the disaster that followed the 1995 that hit the Kobe area, this exuberance is irrational, as the disaster didn’t change economic fundamentals. Monetary authorities did little to stimulate aggregate demand, because they were in a dire situation: they had driven short-term rates to near zero to fight deflation. Fiscal authorities weren’t in better shape either, as they were building bridges to everywhere and nowhere! Stock market gains, as a result were short-lived. After retracing its 25 percent decline in the next twelve months since the earthquake hit, the index continued its decent to new lows.

Policy makers are in even more-dire situation at the time the March 11^th earthquake hit. Thanks to several rounds of quantitative easing both short-term and long-term rates have hovered near zero levels for a prolonged period of time. This means that investors who buy into Japanese stocks now shouldn’t expect a boost from lower rates, and a boost from fiscal policy should be minimal, as money is expected to shift from building bridges to nowhere to repairing bridges to somewhere. Government’s hand to spend freely on infrastructure is further constrained by the country’s heavy debt burden that approached 200 percent of the GDP before the disaster.

Patient investors, however, may want to pursue three investment ideas—all trading in NYSE:

iShares MSCI Japan Index Fund (NYSE:EWJ)—a diversified fund that invests in the major stocks that are included  in the MSCI Japan Index. The fund pays 1.38 percent dividend and has a low expense ratio of 0.53; and trades in large volume.

Japan Smaller Capitalization (NYSE:JOF) –A closed-ended fund that invests in smaller high technology companies. The fund pays 1 percent dividend and allows investors to take advantage of high tech boom in the Nagoya and Tokyo areas where many of these companies are allocated—away from the earthquake area.

Kubota Corporation (NYSE:KUB). The company is a manufacturer of a broad array of construction equipment, agricultural, machinery, waste and environmental gear, including iron and plastic pipes and filters, water treatment systems, drainage systems, water supply systems, etc.   The company is further expected to benefit from a weakening yen that makes its products more competitive in world markets. Trading at around $46, Kubota’s stock has almost tripled since 2002, while the Nikkei lost almost half of its value. And although its fundamental lag behind those of its US counterparts, reconstruction spending and a weaker yen can reverse fortunes.

Company        Recent            Forward         Quarterly                   Operating

Price               PE                   Profit                 Growth                       Margin

KUB                $46                 15.08              58%                               9.28%

CAT                 $110               13.14              317                                  9.38

DE                   $97                13.12              111.20                            13.13

Source: Yahoo.Finance.com

Disclosure: Long on EWJ and KUB