Foreign investors lured to Japan by promise of recovery

A security guard walks at Toyota Motor's showroom in Tokyo June 17, 2011.

TOKYO (Reuters) - Foreign investment may flourish again in Japan as value-hunters return to a market that is slowly rebounding after the March earthquake, but only if the country can break the political impasse that is blocking policies to deal with its nuclear disaster and massive public debt.

Investors are eyeing companies with global exposure that have become cheap after a post-quake market rout and proved resilient despite damage to their supply chains and production capacity, which are now coming back online faster than even the most bullish expectations.

Overseas players have pumped 5 trillion yen ($62 billion) into Japanese stocks in a record-long buying streak since November and a record 893 billion yen in the week after the March 11 quake, betting the current recession will be followed by a sharp recovery.

At the Reuters Rebuilding Japan Summit on June 20-22, leading corporate executives, investors and policymakers will discuss how to tackle the litany of challenges facing the country and achieve a sustained recovery.

"Japan stocks are very cheap. Even though there's a lot of uncertainty going forward, we see indications that manufacturing is coming back to normal and we may see a 'V' shape recovery," said Jonathan Allum, equity strategist at Mizuho International in London.

Still, with the Federal Reserve's $600 billion bond buying programme ending this month, deepening euro zone debt woes and further tightening in fast-growing markets, foreigners' buying has waned recently, underscoring the urgency with which Japan needs to address policy challenges to make itself attractive again.

Manufacturers face a grave risk of massive power shortages as nuclear reactors are gradually shut under intense public pressure after meltdowns at the quake-hit Fukushima nuclear plant, and as Japan's divided lawmakers struggle to overhaul energy policies.

More importantly, Japan's biggest rebuilding effort since the post World War Two period may be seriously hampered as politicians wrangle over who should foot the bill for the worst nuclear disaster in 25 years.

"Until the equity market has got some sort of basic idea that this is the bill, this is the way it's going to be shared, and these are the implications for individual companies, it's very difficult for anyone to place any aggressive bets," said Alexander Kinmont, Japan Strategist at Morgan Stanley MUFG Securities.

"That's particularly true for financial stocks, which are, together with utilities, in the firing line in terms of private sector burden-sharing. It's just very difficult for the market to achieve any sort of level of basic confidence that there won't be any unpredictable surprises," Kinmont said.

Analysts also say many investors eased their buying due to concerns that Japan has to issue more debt to fund this year's $1 trillion budget and pass an extra budget to pay for reconstruction, adding to a pile of public debt, already twice the $5 trillion economy.

"But I think debt financing will go smoothly, and Japan won't turn into a 'second Greece' -- that's when overseas players may turn their eyes to Japan stocks as they trade around book value, suggesting a very limited downside risk as Japan has rarely been cheaper before," said Yoshito Sakakibara, an economist at JPMorgan Chase Management in Tokyo.

Thomson Reuters StarMine shows Japan trades at the biggest discount among developed markets, with valuations at just 8 times forward earnings, compared with 10.5 times for Asia and as much as 12.7 times for the U.S. market.

That means Japan trades roughly on par with Argentina and Romania, Starmine showed.

HUNT FOR VALUE

Investors do see the potential, but they still remain cautious.

In a recent Goldman Sachs survey of investors, 40 percent expected the Nikkei to break above 10,000 yen by year-end, implying a gain of around 7 percent from current levels. More than a quarter predicted it could even top 11,000 yen -- a level not seen in over a year.

As the recovery comes within sight, market players scramble to streamline their investments to the most promising sectors.

A survey by Bank of America Merrill Lynch last week showed fund managers are hiking their weightings in machinery and autos sectors and its survey of Japan-resident institutional investors revealed autos were the most overweighted sector, advancing from 16 percent to 28 percent.

In the past month, the auto industry saw the biggest upward revision in analysts' 12 month earnings predictions according to Thomson Reuters StarMine. It showed a potential for 23.9 percent in profit growth for autos and components compared with 1.9 percent for all Japan in the current fiscal year.

The weighting of automakers in the Nikkei 225 adds up to roughly 5.6 percent, Thomson Reuters data showed.

"The stocks we like in the portfolio are exporters so companies like Honda for example could do quite well as production is normalising," said Virginie Maisonneuve, head of global and international equities at Schroders.

Toyota Motor Corp (7203.T), despite trading at fairly rich valuations, also is attracting investors' attention due to potential for profit growth.

Top analysts tracked by StarMine estimate its earnings growth in the current fiscal year to reach almost 40 percent and nearly 84 percent in the fiscal 2012, sharply contrasting with fairly modest predictions for its U.S. and Korean rivals.

"It's pretty simple. The outlook points straight back to 'quality' companies -- those that are globally relevant," said Michael Newman, head of Japan equity sales at Macquarie Capital Securities.

"I guess it all goes down to 'you pay for what you get.'"

(Additional reporting by Kei Okamura; Editing by Kim Coghill)