Big in Japan

Abe hasn't defeated deflation but he has turned the nation into a magnet for foreign investment.

Shinzo Abe doesn't deserve a prize for slaying deflation, at least not yet. After three years of unprecedented monetary easing, bond traders' 10-year inflation expectations for Japan are nowhere close to the prime minister's 2 percent target. Yet there's a lesser award Abe has most certainly earned: he's turned squarely developed Japan into a hot target for funds that would otherwise have flowed to emerging markets. 

Comparing Japan with emerging markets might sound like an insult. The original Asian miracle nation is, after all, home to more shareholder value than French, German and Australian markets combined. But the award is bestowed in all earnestness. At a time when traditional emerging markets are mostly submerging, the land of the rising sun is luring investors to its shores.

And for once, Japan's promise is not merely safe harbor from global high-yield turmoil, but honest-to-goodness earnings growth combined with efficient use of capital. The U.S. is still far ahead when it comes to investor activism, but the kind of return on equity one would typically associate with a fast-growing developing economy is increasingly within shareholders' reach:  

Japan Emerges as Emerging Markets Submerge

Return on Equity

Source: Bloomberg

Investors were bound to take note, and they have. In the current quarter, Japan has attracted almost $13 billion of equity investment from foreigners. Most other markets tracked by Bloomberg have seen net outflows.

Japan Lures Investors Fleeing Global Turmoil

Foreign equity investment in current quarter (Oct-Dec. 2015)

Source: Bloomberg

There are at least three reasons why the outlook for 2016 might be even better:  

  • Japan doesn't export commodities. 
  • It doesn't usually borrow in dollars. 
  • It has no reason to fear the Fed. 

The first two of those three advantages have already give Japan a huge leg-up. Practically all emerging markets  are either grappling with the fall out of a China-induced collapse in energy, mineral and metal prices or struggling to repay dollar debt out of revenue earned in their tanking home currencies. But because Japanese companies generally borrow in yen, they have no reason to fear higher U.S. interest rates. The 29 percent decline in the Japanese currency that Abe has presided over since coming to power in December 2012 will continue to bolster auto and electronics exporters' earnings, as well as help them shore up their research and development budgets.

Small Premium

Price-to-earnings ratio

Source: Bloomberg

From car makers like Toyota, Honda and Nissan to robotics company Fanuc and game console manufacturer Nintendo, as many as 120 Japanese companies with a combined market value of almost $750 billion get less than 25 percent of their sales from within the country. To them, a weak exchange rate matters crucially.

After a 5 percent jump so far this year, the MSCI Japan index is about 18 percent more expensive than the MSCI Emerging Markets benchmark. But if the Bank of Japan gets impatient enough about meeting its elusive inflation target to crank up its money-printing campaign, the current premium for owning a market that's beginning to emulate some choice emerging-market characteristics might in hindsight appear like small change.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Andy Mukherjee in Singapore at

    To contact the editor responsible for this story:
    Katrina Nicholas at

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