Why Japan Matters to U.S. Investors

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Eurozone, move over! It's been a long time since the Japanese stock market was the focus of investors around the world, but it's now starting to steal the spotlight. The Nikkei 225 is up 56% over the past 12 months. That remarkable rally largely coincided with the accession to power of Prime Minister Shinzo Abe last December, and now it's giving way to a new phase that began around mid-May. The equity market is now exhibiting extraordinary daily volatility, with daily gains or losses of 3% or more becoming commonplace.

Today, for example, the Nikkei 225 shed 6.35%, which loss reverberated across Asia and Europe -- though not, it seems, the U.S., where the S&P 500 and the narrower, price-weighted Dow Jones Industrial Average are up 0.15% and 0.13%, respectively, as of 10 a.m. EDT. Cumulatively, the index has now fallen 20.3% from its May 22 high. Technically, that puts it in bear market territory:

^N225 Chart

^N225 data by YCharts.

A year ago, when Japan's Topix index hit a 28-year low, buyers of Japanese stocks were likely buying with a margin of safety (the Topix is a market-capitalization-weighted index that is a better reflection of the Japanese market than the more widely known Nikkei 225). Today, that same proposition is a lot less appealing, with valuations higher and risk more sharply defined.

Could any of this affect the U.S. market? While Japan plays a key economic role in Asia, the direct impact on the U.S. is limited (although people often forget that Japan remains the third-largest economy in the world, just behind China.) Why, then, is Japan attracting attention? For one thing, U.S. investors are now experiencing phenomena similar to, albeit less extreme than, those affecting their Japanese counterparts: the end of a one-way, "lockstep" market and rising volatility.

Secondly -- and this is cumulative with the first factor -- the real-estate and stock-market crash that hit Japan from 1990 onward is the closest parallel in living memory to the recent financial crisis in terms of its nature and magnitude. Japan remains an ongoing case study in crisis management that has nearly a two-decade head start with respect to the global financial crisis, and there is always a latent fear among investors, academics, businesspeople, and policymakers that the U.S. could "turn Japanese."

Third, the recent stock-market volatility in both countries is linked to uncertainty regarding the central banks' use of extraordinary policy tools.

The next several months should be interesting indeed. Expect volatility to remain a part of the summer forecast.

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The article Why Japan Matters to U.S. Investors originally appeared on Fool.com.

Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned; you can follow him on LinkedIn. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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