Japan Can't Compare to U.S., China

In the last few weeks, there have been a number of reports about how Japanese shares look ready to rally. Since hitting a 52-week low of 14,837 at the end of November, the Nikkei index has gained 5%, in line with similar growth in China, and Hong Kong, which has surged 7.5%.

But investors should be wary of making overly simplistic calculations based purely on what are admittedly cheap valuations in Japanese equities.

Cheaper Isn't Better

Capital-outflow numbers make for worrying reading: While Asia ex-Japan lost some $17 billion toward the end of October, Japan saw $7 billion in outflows. At a whopping 41% of the much larger Asian region in general, this number implies that foreign investors got rid of their Japanese holdings before unloading anything else. Given more regional turmoil, there is little reason why that shouldn't happen again.

Also, many foreign investors adopt a dollar-cost-averaging approach to investing, buying into the market as the yen shows signs of weakening.

On the upside, of course, one can argue that with the yen hovering around 110 to 111 vs. the dollar, the Japanese currency has lost 2% in the past couple of weeks. It also shows signs of continuing in that direction in Asian trading. That makes Japanese shares look even cheaper now.

Interest-Rate Expectations, Interest-Rate Effects

But much of this is due to an expected U.S. interest rate cut, rather than genuine weakness in the yen. On Monday, the Tokyo Financial Exchange introduced futures on overnight interest rates to allow foreign investors to speculate on changes in Japanese interest rate policy. So far, these futures seem to have had a punishing effect on the yen, keeping the currency weaker than at the end of last month.

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Daniel M. Harrison is a business journalist specialising in European and emerging markets, in particular Asia. He has an MBA from BI, Norway and a blog at www.theglobalperspective.biz. He lives in New York.