Guru Strategy: Investors beware, Japan could be a value trap

Global investors, beware: Japan could be a classic value trap.

Japan's central bank took an aggressive stance against deflation on Tuesday, announcing it will inject $115.7 billion into the economy. So far, the move has not been dramatic enough to bolster the market significantly or impress economists. Japan's Nikkei index was up 3.4% at the close of the day.

While the move comes on the heels of good news, investors seeing an opportunity to profit should be wary. Yes, Japan has posted two straight quarters of economic growth. In its third quarter, gross domestic product grew at an annualized rate of 4.8% due to strong demand for Japanese products. When you combine the country's recent growth with its anti-deflationary measures, you would think you have a recipe for a rebounding economy -- and profits for investors.

But Carlton Delfeld (pictured), the head of global advisory firm Chartwell Partners, says that investors who now see a silver lining in Japan's economy -- and who are buying shares in exchange-traded funds such as iShares Japan (EWJ) and iShares Japan Small Cap (SCJ) -- could be in for trouble.

Delfeld, who is also the editor of Chartwell and, warns that Japan's economy is far from healthy. Part of Japan's problem is the rise of China and other emerging markets in the region. While China's GDP has increased tenfold during the past decade, Japan's (which is 10 times that of China) has been flat.

Over the past two decades, the Chinese economy grew about 10% a year. But over that period, Japan stagnated as huge public works projects aimed at reviving the economy went toward protecting moribund industries instead of fostering new ones, says Delfeld. The initiatives failed to lift Japan out of its doldrums and instead created a huge debt burden.

China has also surpassed Japan in having the biggest trade surplus and foreign currency reserves, as well as the highest steel production. And next year, China could overtake Japan as the largest automobile producer.

Japan's traditional strengths such as its educational system, management style and homogeneous population in some cases are looking more like liabilities these days. What's more, the country has seen several bubbles burst. Commercial property prices fell 87% from their peak, golf course memberships plunged 95% and the country's lost wealth during this decade equaled three years of its annual GDP. By comparison, during the Great Depression, the U.S. lost 50% of its GDP from 1929-1933.

Delfeld's list of Japan's economic troubles goes on:

  • The per-capita gross domestic product of Japan, which surged past that of the United States in the late 1980s, is now a quarter below American levels and 19th in the world
  • Unemployment stands at a record high of 5.7 percent. Japan's economy shrank at an annualized rate of 11.7% in the first three months of the year before recovering to a modest 2.3% annual rate of growth in the second quarter.
  • As a result of the global financial impact on Japan's key export markets, production and exports slumped as much as 40% this year.
  • Today, not a single Japanese company is among the global top 10 in market capitalization. In 1988, Nomura Securities issued a ranking of companies by market capitalization, and 8 of the top 10 were in Japan, topped by Nippon Telegraph & Telephone. Toyota ranks No. 22, at $144.5 billion, and only five other Japanese companies made the top 100.
  • Annual growth in Japanese gross domestic product averaged 10.4% in the 1960s and 5% in the 1970s, but only 4% in the 1980s and 1.8% in the 1990s, according to Goldman Sachs. In the first decade of this century, growth has been even slower.
  • A series of 10 stimulus packages and slow growth have led to a gross public debt to twice the size of its $5 trillion economy -- by far the highest debt-to-GDP ratio in recent memory. Each failed to cure the recession.
  • The International Monetary Fund expects Japan's gross public debt to reach 218% of gross domestic product (GDP) this year, 227% next year and 246% by 2014. Meanwhile, Japan's savings rate has fallen from 15% in 1990 to near 2% today, half of America's rate. Japan's $1.5 trillion state pension fund (the world's biggest) has become a net seller of government bonds this year, as it must to meet growing obligations.

Delfeld says that while investors shouldn't completely rule out a recovery, Japan's economic decline will likely accelerate as China captures Japanese export markets and as Japan's crushing national debt increases and its aging population grow less and less productive.

The upshot of all this: If you still plan on investing in Japan, you'll need a stomach that can handle a lot more than wasabi.

Carl Delfeld's Chartwell Advisors operates two ETF Websites, and His bookRed, White and Bold: The New American Century is now on sale.
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