Investing in Japan? Think twice

If you are a foreign investor interested in investing in Japan, think twice and consider these facts before putting money in Japan. In short, having a stake in Japan is like part gold investing and part bond investing. Let's see why these investments are alike and what you can expect from investment in Japan.

There are mainly two ways to invest in Japan: holding Japanese Yen and buying Japanese companies. Combining these two investments works as a cash cow. How can buying stocks end up with stable cash flows? The answer is dividends and stronger Yen. Japan is a declining country and that is undeniable, but companies are not. Japanese companies have some competitive edge and they are exporters. As long as they keep making money in foreign countries, the stocks will thrive. Here is some basis for the Japan-as-a-cash-cow theory.

JapaneseYen like gold

Japan has no inflation
Japanese Yen is like gold because it has no inflation. For more than 20 years, Japan has experienced years of no inflation. The source of inflation is still unclear and economists debate where does inflation come from, but the important fact is that Japan has consistently lower inflation than other countries. The economic structure might be behind it. Exporting countries have account surplus and therefore their home currencies face permanent pressure to strengthen. Japan is no exception. That would make lower inflation and foreign investors get boost from stronger Yen.

Japan has one scarce resource: water
Safe havens need to have some backing assets, or more specifically stores of value. Japan is not a big country, nor has rich resources. However, it is surrounded by sea and has plenty of water. Not many countries have that. In case of water scarcity, Japan could export water. Costs may be a concern, but the fact that Japan is a water-rich country is encouraging if you take account of environment.

What will happen when Japan defaults?
Japan is one of the most indebted countries in the world, but that debts mostly owe to Japanese citizens. If Japan defaults, there would be massive reduction in social securities. Unsustainable pensions and national health insurance would be cut significantly to reduce the burden. Combinations of budget cut, tax hikes and debt haircuts are likely results. These would be necessary, but one thing Japan should avoid is selling US treasuries. That is a Pandora's Box and if that happens, the world would be thrown into chaos and Japanese Yen will strengthen.

Japanese stock like bond

Japanese companies stay afloat
Japan is the most advanced country among developed nations in terms of declining population and aging society. The future of Japan is not bright for sure. The country is not growing and won't grow much or even will shrink, but that doesn't translate into declining corporate profits; companies can make profits elsewhere. Fertility rate in Japan is at around 1.4, so aging and population decrease is unstoppable. However, the decline is not very rapid and corporate profits are less dependent on Japanese GDP. Japanese stocks are not strong buys, but they're not something that disappears instantly and they won't vanish in the near future.

Japanese companies have record amount of cash
The trend is world-wide after the financial crisis of 2007-08, and Japanese companies are typical. Demands in Japan is decreasing and corporations worry about sales, so it's natural that Japanese companies save cash to prepare for uncertainties. They are reluctant to spend on investments and wage increase is almost non-existent so there is no other way to spend money on stock buybacks and doing M&As. Corporates' cash pile is a problem for economies, but not for investors as having more cash makes companies safer.

Japanese companies started paying more dividends
Japanese stocks had been paying less dividends as they like to have cash on hand, but thanks to increasing foreign investors (now 30%+ are foreign owners), they started to pay more. How long this trend will last is uncertain, but this is a welcoming trend and should attract interest-hungry financial institutions around the world.

Investing in Japan is defensive
Aging Japan is declining and there is no cure for that, but the export-driven economy will soften the impact and put pressure on Yen. Low inflation and creditor nation status also keep Yen strong. Cash-rich Japanese companies might not grow much but do reasonably well and pay more dividends. In sum, because of stronger Yen and steady dividends, investing in Japan will be like interest-paying gold investment. It won't yield big sum, but it's a good destination for diversification.