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Japan’s Prime Minister Shinzo Abe aims to revitalize the world’s third-biggest economy.


It's been a wild spring for investors with a stake in Japan. From April 2 to May 22, the benchmark Nikkei 225 has rocketed 30 per cent. Since then it has plunged more than 17 per cent – with plenty of thrills and spills in between.

Investors are reacting to what has become a bit of an experiment for the Japanese economy. Before spring bloomed, the newly elected government of Prime Minister Shinzo Abe and the Bank of Japan set an unprecedented plan in motion. They pledged a flood of monetary and fiscal stimulus and loosened the regulatory reins. The goal is to get inflation to 2 per cent by the end of 2014, ending two decades of economic stagnation.

As a result, the value of the yen plunged, creating a competitive advantage for the same exporters who have made postwar Japan the world's third-largest economy. Even the domestic economy is taking its cue as business and consumer spending ramps up.

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The yen has since rallied and has strengthened since then. Despite the rough start, Seijiro Takeshita, director of London-based investment bank Mizuho International PLC, says the new measures are just what Japan needs to kick-start the economy.

"People only talk about the direct benefit that they are going to get from the yen but there is a bigger, longer-term side. This normalized yen enables Japanese exporters to regain their competitiveness in their pricing side," he says. "They have lost out so much market share to the [South] Koreans and the Germans on this hyper yen. It's time for them to claw back quite a lot of their market share."

He says the new policy, dubbed "Abenomics," will get a second wind on July 21 when the party of Mr. Abe is expected to win a victory in Japan's upper house. The win would give the Liberal Democratic Party (LDP) more power to impose reform by having a majority in both houses.

Dr. Takeshita says the recent rally in Japanese equities will continue and is telling his clients to get in before valuations climb too high. He admits prices are slightly higher compared with earnings on the S&P 500 but says earnings in Japan are based on "excessively pessimistic demand forecasts."

"The E within the P/E [price-earnings] ratio is going to substantially increase here onwards," he says.

Investment bank Mizuho International has raised its forecast for the Nikkei 225 to 16,000 from about 12,900 now. Dr. Takeshita says globally competitive, export-oriented machinery and automakers will lead the surge.

Mizuho ranks as buys some familiar Japanese stocks that trade on U.S. exchanges, such as American Honda Motor Co. Inc., but he warns the automaker could be getting expensive. His best-value recommendations are traded over the counter or can be purchased on foreign exchanges through a brokerage (be sure to ask about trading fees). Some of the stocks can also be found in mutual and exchange-traded funds.

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Two of those companies are diversified manufacturers Hitachi Ltd. and Toshiba Corp. "They focus on things like nuclear generators and social infrastructure that would benefit from growth in Asia and emerging nations," he says. Both stocks are up about 30 per cent this year despite the sell-off.

Mizuho recently upgraded the machinery sector. One company that tops the buy list is Omron Corp., which manufactures components for factory automation. Omron stock is up 44 per cent so far this year.

One recent upgrade to a buy is heavy-machinery maker Komatsu Ltd. "If there is any turnaround in China or continued growth in emerging nations, this is the Caterpiller of Asia," he says.

Dr. Takeshita expects a lot of new investment in Japan to come from within, citing pent-up demand. "The Japanese have been underinvesting for more than six years which has almost reached a dangerous level," he says. "Over 45 per cent of Japanese machine tools are over 15 years old. When you have a demand flow kicking in they are bound to tip toward increasing capacity output, which increases capital expenditures."

Two domestic stocks he recommends to clients are information technology research consultants Nomura Research Institute and e-commerce firm Rakuten Inc.

Not everyone is as optimistic about the sustainability of Japan's recovery, though. Richard Kelly covers interest rates and currencies at the London office of TD Securites. "Like any monetary policy these days you can sustain moves in the market for as long as the central bank is willing to be aggressive and increase its aggressiveness as the data disappoints," he says. "I think there are very large questions as to how successful they can be in the medium term."

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Mr. Kelly says high government debt levels could impede the Bank of Japan's efforts to get inflation up to 2 per cent. "You can start to push up inflation expectations early by getting this very aggressive monetary easing and buying assets and talking about targets but eventually you need Japanese companies to start increasing the wages of workers and give them the pricing power to push up prices. That's something they can't really do until they get profitability going."

He says Japan still needs to deal with problems lingering for what is now two lost decades, such as its aging population and low birth and immigrations rates. While investment and productivity are likely to increase, he says a recovery cannot get support unless the labour force grows with it.

"One of the three basic fundamentals is in a structural decline for Japan and it will be for quite some time. They're not alone in the world. They're just one of the first to get there."

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