The Analyst: Japan is looking like an interesting bet

I have to cast my mind back to 1987 to recall a sustained period of stock market volatility similar to the spell in recent weeks. Rises and falls of 1 per cent, 2 per cent or 3 per cent a day are seemingly a matter of course, along with a few bigger ones of close to 5 per cent sprinkled in. Hardly a helpful environment for long-term investors already frightened of committing funds to the markets. A possible solution is to drip-feed money into areas you think offer value on the poorer days, though even this can be tricky psychologically.

One region that has virtually become a no-go area for private investors is Japan. It is perfectly understandable. Since the heydays of the 1980s, Japan's stock market has been an exceptionally poor performer, although the considerable strength of the yen, up more than 80 per cent in the past 20 years against sterling, has mitigated the losses experienced by overseas investors. There have been so many false dawns on Japan over the years that investors are rightly sceptical, but a recent meeting with Stephen Harker of GLG Japan CoreAlpha Fund highlighted to me that Japan is now very, very cheap.

Mr Harker believes the market is already incredibly oversold. He notes the Japanese stock market has been the worst performing developed-world stock market in every downturn since 1988 – with the exception of the most recent one. Despite the global credit crisis rumbling on and the challenges created by the tragic tsunami in March, the Topix index is down only 9 per cent since the start of the year in yen terms. Perhaps this resilience means it really has reached rock bottom?

Stephen Harker has had a poor year to date in terms of performance. The real action has been in smaller company stocks with exposure to the BRIC economies, but he believes this cycle is now coming to an end and conditions are set to be more favourable for his fund, which invests in the largest Japanese stocks. Always a great contrarian, Mr Harker disagrees with the consensus view that Japan should benefit from its proximity to China. While bearish on China anyway, he believes China is "eating Japan's lunch", gradually taking market share from Japan's manufacturing sector. He argues an economic downturn in China will actually benefit Japan as it will mean lower commodity (especially copper) prices, which should boost Japanese company profitability.

Among Japanese stocks he be-lieves financials are especially cheap. Having been through a deleveraging process over many years there is little sign of economic distress, and Japanese banks have already been outperforming those in other global markets. Interestingly, retailers are also having a good run with consumer confidence seemingly growing.

This is not to say that Mr Harker is bullish about the global economic outlook. He is not, but he does believe Japan is poised to outperform. It went through its own credit crisis some years ago and most investors have given up on the market having had their fingers burnt, so valuations are exceptionally undemanding. Japan's public debt pile is often cited as a catastrophe waiting to happen, but Mr Harker believes it can be overcome. Japan effectively owes itself money, with the debt principally owned by domestic investors who may, in Mr Harker's view, have to take a haircut on it at some stage.

As usual the yen is the wildcard for overseas investors in Japan. Mr Harker's view is that the yen may weaken slightly, and this will be beneficial to Japanese companies whose exports would become more competitive. It is important to note, however, that many Japanese multinationals gave up on their domestic economy years ago and have operations all round the world. They are truly global businesses not reliant on Japan itself. It is unusual for Mr Harker to suffer underperformance for three quarters in a row and I note another fund manager, Paul Chesson of Invesco Perpetual, has had a similarly difficult time. If you are a contrarian investor, gradually allocating some money into Japan looks like an interesting bet right now, and this fund is a high-quality choice.



M ark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds included in this column, visit www.h-l.co.uk/independent

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