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Latest Elections Signal Upside in Japanese Stocks

NEW YORK (TheStreet) -- Asian stocks are seeing some buying activity early in the week as Prime Minister Shinzo Abe's upper-house election victory implies a continued government commitment to monetary stimulus programs in Japan.

The results solidify control for Abe's Liberal Democratic Party (LDP) over both parliamentary chambers, and gives the Party the green light to implement economic reforms. On the whole, these proposed reforms are positive for the country's stock markets (export companies, in particular), and negative for the Japanese yen.

For ETF investors looking to gain exposure to the region, this translates to a bullish scenario for the iShares MSCI Japan Index ETF (EWJ), and a negative outlook for the CurrencyShares Japanese Yen Trust (FXY).

The Abe victory was largely in line with the expected results. But at the same time investors have reasons to be skeptical, given the fact that in the past 20 years we have seen about 15 different prime ministers in Japan that have promised economic reform programs but produced little in the way of real structural change.

There is, however, some reason to believe that this time is somewhat different. Since Abe re-entered public office in December, policy changes have helped to revive the Japanese economy (the third-largest in the world), as massive stimulus programs have boosted public works, established long-term consumer inflation targets, and flooded the market with more than $130 billion in monetary stimulus injections.

These programs helped generate strong rallies in Japanese stock markets, with the Nikkei 225 and TOPIX up by about 40% for the year to date. Now that the LDP has a strong mandate to continue to enact supportive economic measures, these stock rallies should continue to show long-term upside. More details about the specific reform strategies to be implemented by the LDP should be announced in September, but at this stage it is clear that Abe's intention is to continue enacting measures that support markets and and bring the country closer to its 2% consumer inflation target.

Given the strength of the performance that has been seen in Japanese stocks already this year, some will argue the "easy money" has already been made. But when we look at instruments like the iShares MSCI Japan Index ETF and the Nikkei 225 as a whole, we see stock valuations that are still trading well below their historic bull levels.

With vaulations still about 60% below their long-term highs, Japan offers some excellent opportunities when compared to the other major markets. This can be seen in the price to book values for the country's stocks, relative to other areas of the world: Price-to-book values in the Topix are seen at 1.3, while the S&P 500 currently trades at 2.5 times its book value and the Stoxx Europe 600 trades at 1.7 times its book value.

With the recent election results and comparative valuations seen in Japanese stocks, significant upside can still be found in the iShares MSCI Japan Index ETF relative to its major market counterparts. Abe's reform policies, which are designed to trigger upside in consumer spending and support investment, could still meet opposition as these measures add to Japan's already-excessive public debt levels (currently near 240% of annual GDP). But the latest election results help ensure some level of political stability, and a stated commitment to accommodative monetary and fiscal policies.

Now, the focus remains on implementing the LDP's growth strategies and corporate earnings. Abe's victory helps solidify Japan's strategic path going forward, making it more likely the country's stock benchmarks will be higher by year's end.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

Stock quotes in this article: EWJ, FXY 
Richard Cox is a university teacher in international trade and finance, focusing primarily on macroeconomics and price behavior in equity markets. His articles appear on a variety of websites, including MarketBulls.net, Seeking Alpha, FX Street, and others. Investing strategies are based on technical and fundamental analysis of all the major asset classes (stock indices, currencies, and commodities). Trade ideas are generally based on time horizons of one to six months.

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