“I’m convinced we’re witnessing the lowest-risk, highest-reward trade in 61 years.”
That’s what I told WSD Insider subscribers regarding Japan back in December 2011. Unsurprisingly, many balked at my assertion. Too many pundits for too long had been predicting the same turnaround for this country’s stocks. And every time, one never materialized.
But guess what? This time – dare I say it – could end up being different.
And that’s because the specific Japanese stocks I recommended are showing signs of a breakout. They’re on a record-setting tear, up 26 days in a row, in fact.
It’s not just a glitch, either. There’s momentum, valuation and positive fundamentals driving it home.
So, surprising as it might seem…
It’s Finally Time to Bet on Japan
I know what you’re thinking… Why in the world would I invest in Japanese stocks?
The country’s saddled with debt. It’s still reeling from the costliest natural disaster on record. Not to mention, investors betting on an imminent turnaround have been burned time and time again.
But there’s no denying the tape. And small-cap stocks in Japan, represented by the TSE Second Section Price Index, are enjoying their longest winning streak since May 13, 1975, according to Bloomberg.
The streak “suggests money is flowing into the Japanese market across the board,” says Makoto Sengoku, a market analyst at Tokai Tokyo Securities Company.
Let me assure you, though, this is about much more than momentum.
You see, even after the latest rally, Japanese stocks are obscenely cheap compared to U.S. stocks. Particularly, Japanese small-cap stocks. They’re essentially selling for $0.63 on the dollar, based on price-to-book ratios.
Three More Reasons to Buy Japan
It’s important to note that the case for investing in Japanese small caps extends beyond momentum and valuation. Positive fundamentals are also a factor. And here are three you should consider before scoffing at the bullish case for Japanese stocks and small caps, specifically:
- Profit Growth. Japanese companies are expected to increase profits by 38% in 2012 compared to a 9% increase for U.S. companies. Since share prices ultimately follow earnings, that means Japanese stock prices should jump notably higher in price.
- Rebuilding Boost. Although the earthquake hit almost a year ago, a delay exists between the rebuilding efforts and the boost to economic output. The majority of the boost isn’t expected to hit until this year. And the companies that are going to derive the most benefit will be those serving the domestic market – i.e. small caps.
- Low Political Expectations. U.S. politicians aren’t alone. Japan’s two previous prime ministers were also unable to maintain popular support or introduce initiatives to promote economic growth. The result? The bar is set abnormally low for the current Prime Minister, Yoshihiko Noda, who only took office in September 2011. Citizens and investors alike should embrace any signs of early promise and bid up stock prices.
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Follow the Smart Money
If you’re still not convinced yet to buy into Japan’s rebound, maybe this will do the trick: Institutional money managers – the so-called “smart” money – are changing their minds.
Josh Strauss, of Appleseed mutual funds, now holds about 17% of his fund’s assets in Japanese stocks. David Herro, of Oakmark International I Fund (Nasdaq: OAKIX), has 25% of his portfolio invested in Japan. And then there’s Charles de Vaulx, of International Value Advisers. More than 40% of his IVA International A Fund (Nasdaq: IVIOX) is invested in Japanese stocks.
Granted, these managers are exceptions to the norm. Most mangers still shun Japanese stocks altogether. But it does represent a shift in sentiment and behavior. And I’m convinced it’s a leading indicator.
Once more money managers jump on board the Japan trade, look out! Prices are bound to jump higher in a hurry. Given the rock-bottom valuations, there’s certainly room for the stocks to run.
Bottom line: Japanese stocks are dirt-cheap with positive economic forces at work. And small-cap stocks represent the most compelling bargains. If you can stomach being a contrarian, step up and buy. Before it’s too late.
Ahead of the tape,