5 Reasons Investors Should Not Bail on Japan

By Ben Baden

Why Japan remains a force in the world economy

Usually when the Japanese economy makes headlines, it's for all the wrong reasons. The country's public debt-to-GDP ratio clocks in at 225 percent -- more than three times as high as that of the United States. Japan has been trapped in a deflationary struggle for decades, and its economy doesn't show signs of recovering any time soon, especially in the aftermath of last week's earthquake and tsunami, and amid concerns about a damaged nuclear plant. But despite its hardships, Japan is still a legitimate force in the world economy, and many trade partners, including the United States and China, depend on exports from a range of Japanese companies. Here are five reasons investors shouldn't abandon Japan:

Crises breed overreaction.

Before Friday, the last big earthquake hit Japan in January 1995. Six months after the quake, the Nikkei 225 Index was down 25 percent, according to Bespoke Investment Group. But by the end of the year, the index regained all of its losses. When it comes to major market-moving events like natural disasters, investors generally sell first and ask questions later. "You always have to look at special situations where fear and greed creep in as potential opportunities, because usually the pendulum swings a little bit too far the other way," says Christian Magoon, CEO of asset management consultant firm Magoon Capital. Keep in mind, however, that the 1995 quake's damage didn't include a nuclear plant.

Pro-business government.

Late last year, Prime Minister Naoto Kan announced that Japan will cut its corporate tax rate -- currently the highest in the world -- by 5 percentage points, down to 35 percent. "[The government is] doing everything they possibly can to help Japanese companies," says Neil Hennessy, chief investment officer for Hennessy Funds, which includes two Japan-focused funds under management. The Bank of Japan has also taken an aggressive role in trying to create liquidity in the Japanese market by buying up hundreds of billions of dollars' worth of Japanese securities. "Both sides of the aisle are working toward fixing what's broken now in Japan," Hennessy says.

It's cheap.

Even before the Nikkei Index's massive sell-off this week, Hennessy says the country's stocks were cheap from a valuation standpoint. According to his price-to-sales ratio estimates, Japan is about three or four times cheaper than its BRIC counterparts -- the fast-growing markets of Brazil, Russia, India, and China.

Audrey Kaplan, manager of the Federated InterContinental Fund, which had about 15 percent of its assets invested in Japan as of the end of February, is cautiously optimistic. "If we could get some resolution around the nuclear situation, the sell-off could be a very attractive opportunity to buy, and we would consider shifting from neutral to overweight [in Japan]," she says. "We're just looking for more clarity."

It's still the world's third largest economy.

While no one is forecasting stellar growth for Japan in the near future, it still remains the world's third largest economy, behind the United States and China. Before the earthquake hit, the International Monetary Fund expected the Japanese economy to grow by only 1.6 percent in 2011. (The United States, on the other hand, is expected to grow by 3 percent.) But this natural disaster comes at a time when the global economy seems to have turned the corner. "On the positive side, we were in a strong global recovery," Kaplan says. While the fallout from the nuclear reactors is still yet to be determined, "there has not been permanent damage to the industrial base," she says. Companies like Toyota have temporarily shut down manufacturing plants, but these may only be short-term setbacks.

Japanese companies rely on exports.

It's important to remember that the Japanese economy is primarily driven by its exports. When you take a look at Japanese companies, Hennessy says, "remember you're not investing in the Japanese economy, you're investing in global companies that happen to be located in Japan." Slow growth in Japan's domestic economy doesn't necessarily translate into low returns for the country's stocks.

Among Japanese companies, Kaplan is focused on those poised to benefit from growth in neighboring countries like China as well as on the other side of the world in the United States. "We've been overweight [in] companies that are connected to the global growth story, particularly Asian growth, as well as technology companies," she says. Kaplan is currently avoiding Japanese companies in the rail, utilities, and banking industries in favor of lesser-known names like global auto-parts supplier Sumitomo Electric Industries, as well as car industry giant Honda.

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