A contrary opinion on Japan: only six percent of money managers in a Barron’s survey expect Japan to outperform over the next 12 months.

Is it time to double down on Japan?

The following article was originally published in “What I Learned This Week” on November 16, 2017. To learn more about 13D’s investment research, please visit our website.

In Barron’s October 2017 money manager survey, 45% of respondents said they expect emerging markets to outperform over the next 12 months. Of the remaining 55%, 29% chose Europe, 13% chose the U.S., 7% named China and only 6% selected Japan, which is a major contrarian signal to add to Japanese equities (see chart below).

The currency market is sending another contrarian signal. As of November 7th, the JPY short-position increased to 128,000 from 119,000 the prior week — the largest short position on the Japanese yen since January 2014, according to Forexlive.com (see the following chart). One month ago, in WILTW October 19, 2017, we warned about the implications of a potential break in the once- strong correlation between the yen and the Nikkei, as follows: “Most investors believe there is a strong correlation between a weak Japanese yen and a rising Nikkei, but the yen’s long-term momentum and technical profile suggest a bull- market in the yen has perhaps already started. And, the bull market in Japanese equities is now no longer stoppable by a stronger yen. This is yet another mindset that could be challenged, which is classic 13D thinking!”

Underscoring this thesis, Japan’s economy grew at an annualized rate of 1.4% during the July-September quarter, marking its longest growth streak in 16 years. Moreover, despite the recent 26-year high in the Nikkei, Japanese equities are now cheaper than their U.S. and European counterparts. The Nikkei 225 Index has gained more than 140% since our initial buy recommendation, with the Nikkei at less than 9,000, in WILTW November 1, 2012. As of late October 2017, the forward P/E ratio for Japan stood at 14.2x, versus 17.9x for the U.S. and 15.1x for Europe, according to FactSet data cited by LPL Research, as shown in the following chart.

We have often called Japan the “laboratory” for the rest of the world because its aging demographics represent the “future that has already happened.” One of Abe’s major challenges is to create the conditions that will cause a reversal of the secular decline in Japan’s birthrate, which is shown in the following chart.

In 2016, 976,979 babies were born in Japan, the fewest since the government began tracking the data in 1899. This is also the first time in more than a century that the annual number of new births was below the one million mark. The shrinking population of women in their childbearing years (20s and 30s), which has fallen 20% in a decade to 13.66 million, looms large. On average, one baby was born every 32 seconds in Japan last year, while one person died every 24 seconds.

A major reason behind the shrinking birthrate has been the secular stagnation in wages. According to Trading Economics, average monthly wages were ¥340,778 during the first half of this year, which compares to an all-time high of ¥883,000 per month in December 1997 and is only marginally above 1970s ¥327,000. What family wants children in a world of secular stagnation?

There are nascent signs of improvement, however. Japan’s total fertility rate, or the average number of children a woman bears in her lifetime, has been recovering gradually since hitting an all-time low of 1.26 in 2005, and reached a 21-year high of 1.45 in 2015. Last week, the Liberal Democratic Party’s panel reached broad agreement to provide free preschool education (aged 3 to 5) for all Japanese households, a move set to alleviate the burdens of young working couples. Free university education will also be provided for students from low-income households.

Abe would like to see Japan’s total fertility rate rise to 1.8 per woman by the end of 2025. Last month, after winning the Lower House election, Abe vowed to make education and childcare a priority over balancing the budget.

It is important to acknowledge the growing geopolitical risks to the bullish Japan thesis. North Korea is at the top of the list, especially after three U.S. Navy aircraft-carrier strike groups—the USS Ronald Reagan (CVN 76), USS Theodore Roosevelt (CVN 71) and USS Nimitz (CVN 68)—are now operating in western Pacific waters. This is the first time in a decade that three aircraft carrier strike groups have operated together in this region, according to the U.S. Navy’s 7th Fleet.

Last week, during a joint press statement with President Trump, Chinese President Xi Jinping said: “On the Korean Peninsula nuclear issue, we reiterated the firm commitment to achieving denuclearization of the Peninsula and upholding [the] international nonproliferation regime. The two sides will continue to fully and strictly implement U.N. Security Council resolutions.”

President Trump added: “Today...we discussed our mutual commitment to the complete denuclearization of North Korea. We agreed not to replicate failed approaches of the past...We agreed on the need to fully implement all U.N. Security Council resolutions on North Korea and to increase economic pressure until North Korea abandons its reckless and dangerous path...Together, we have in our power to finally liberate this region and the world from this very serious nuclear menace...”

During a subsequent press conference in Beijing, the U.S. Secretary of State Rex Tillerson gave a more detailed account of their talks, saying the Chinese leadership was in full agreement about North Korea’s nuclear program. Tillerson said: “They [President Trump and President Xi] will not accept a nuclear- armed, nuclear-weaponized North Korea...They’re unequivocal in that statement.”

With winter having arrived in North Korea, daily life will get more challenging for the average citizen, creating fertile ground for an escalation of regional conflicts. Nevertheless, a bull market climbs a wall of worry, implying that a major geopolitical shock, if one transpires, might create a great opportunity for investors who have missed-out on Japan’s equity rally to increase their exposure at cheaper prices.

This article was originally published in “What I Learned This Week” on November 16, 2017. To subscribe to our weekly newsletter, visit 13D.com or find us on Twitter @WhatILearnedTW.