Current Recovery in Japan Drives Renewed Optimism

Japan’s economy continues to show a strong turnaround, and this has helped to drive up the Japanese stocks. After languishing for nearly two decades, Japanese stocks touched a multi-decade high of 18,300 in late February before retrenching down to the 17,656 level as of May 8. In spite of this, the benchmark Nikkei 225 is up nearly 26% from its 52-week low and has rewarded patient investors who might have been holding Japanese stocks, ETFs or index funds.

The Bank of Japan has eliminated its zero-interest-rate policy and has adopted a positive bias towards higher interest rates down the road. At the same time, the central bank wants to make sure higher rates do not impact the economic renewal that is underway in the country.

 At the recent Bank of Japan meeting, the central bank did as widely expected and maintained the country’s key overnight lending rate at a mere 0.5%.

 According to the Bank of Japan’s web site and its governor, Toshihiko Fukui, the bank may still need to increase the borrowing rates down the road regardless of inflation, estimated at close to zero. But the economic growth needs to be sustainable. The country’s CPI is expected to rise a mere 0.1% for the 12 months ending March 2008. The country’s unemployment rate is also at a four-year low of 4%.

 Driving the renewed optimism has been an improving labor market and wages, along with a rise in wealth driven by the upward trend in stocks. Japanese consumers are feeling more confident about their economic situation and this could translate into increased spending. This in turn could fuel corporate expansion and spending, and add fuel to the economic engine.

 The current signs point to continued recovery in Japan. For the investor in North America, it means you need to have some capital in Japan and diversify your portfolio. And unless we see an economic setback driven by the small rate increase, Japan may continue to outperform U.S. markets in the foreseeable future.

 If you are looking to play Japan, there are numerous Japan- oriented mutual funds or ETFs. More aggressive investors may look at Japanese American Depository Receipts (ADRs) listed in U.S. exchanges.