Investors eye an end to Japan's decade-long slump

Investment strategist John Rutledge hopes he's the early bird that gets the worm – and not the one eaten by a fox. That's because the partner at Kudlow & Co. in New York recommends investing in Japan.

Not many analysts dare to do that nowadays. Mr. Rutledge is definitely an early bird.

The Japanese economy has been in the doldrums for a decade. The stock-market bubble burst a decade ago. Tokyo's residential-land values have dropped 60 percent since 1990.

"No country in the world ever grows with falling land prices," Rutledge says.

The Japanese themselves have been putting much of their money abroad – hardly a sign of confidence in Japan's economy and corporate stocks.

Consulting economist Donald Straszheim figures the Japanese invested $33 billion in factories, offices, and other direct investments abroad in 2000, and more last year. Foreign direct investment in Japan is only a quarter of that.

Twelve of 20 of Japan's top money managers are planning to increase the share of their huge portfolios in investments in the United States, says Harald Malmgren, a Washington consulting economist and frequent visitor to Tokyo.

If American investors start putting more money in Japan, the Japanese investment managers will reverse their decision, Mr. Malmgren says.

That plan prompts Rutledge to charge that Japanese money managers "always follow the pack. You never make money that way. Historically, the Japanese may be the worst investors in the world."

What makes this former drafter of economic policy for President Reagan confident in Japan as an investment area is a turnaround in the Bank of Japan's monetary policy.

The bank has at last moved vigorously to stop deflation in Japan, not so much out of conviction, but under pressure from both the troubled Japanese government and from the Bush administration.

As a result, Rutledge expects the Japanese economy to bounce back. Since Japan is the globe's second largest national economy after the US, this is important not only to investors but also to the world's prosperity.

Over the past six months, the Bank of Japan has increased the amount of currency and bank reserves in the island nation by 25 percent – a 50 percent annual rate. That should create more money in Japan; prompt prices of goods and services to rise; improve property, stock, and other asset prices; boost the loan portfolios of banks; and fuel economic growth.

Rutledge blames the Bank of Japan for "wiping out" the Japanese economy for a decade. It did so by lowering interest rates to nearly zero. Bank Governor Masaru Hayami reckoned that would create plenty of liquidity and spur economic growth. Consumers and business, though, wouldn't use that extra money, he complained.

With the prices of goods, services, and property falling, it made little sense for them to borrow and put more yen into these declining assets, even with low interest rates.

Since February, however, the Bank of Japan has been buying 1 trillion yen a month ($7.9 billion) in Japanese government bonds. It also has been intervening in the foreign-exchange markets to buy dollars and depress the value of the yen. Both actions pump up the supply of money.

Many economists have predicted that Japan's slump would continue through this year. But now there are signs of recovery. And Rutledge says some American institutional investors, especially "value" investors, are returning to Japan.

"Our money managers are already increasing their bets," he says.

So far this year, Americans with money in mutual funds investing in Japan have done relatively well.

The average gain of several dozen Japan funds has been 5.2 percent, according to Morningstar, a Chicago firm that tracks mutual-fund performance.

But there are risks. The early-bird investor could get eaten.

One risk is the yen exchange rate. If the yen weakens, as Rutledge expects, it would take a bite from a further rise in Tokyo stock prices for American investors.

Also, the Bank of Japan could change its mind and "go back to old habits," says Rutledge.

He would be more comfortable if the central bank believed its more aggressive monetary policy was wise and should be continued for some time after the economy does improve. If not, any improvement in Japan's economy could be temporary.

If in 1989, just before Japan's economy went into a tailspin, an investor had shorted the Nikkei 225 stock-market average (in effect, borrowed stock, counting on a price decline), and invested outright in the Standard & Poor's 500 stocks, he or she would have made 25 percent per year on average for 13 years.

"Better than a stick in the eye," jokes Rutledge. Times change. Today he wonders if Japan's market "is the rumbling of a big volcano going off."

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