In Japan, Think Local

	Elliott Gue PF Newsletter.com
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The Japanese economy is finally in recovery mode but the well-known Japanese exporters aren't the best way to play the trend. Here's how to profit from the resurgence in Japan's domestic economy.

Exports were the key to Japan's post-war growth. Japan's best-known corporate brands of the 1990s rose from the rubble and anonymity of the '50s.

But Japan's corporate successes masked dangerous domestic realities. By the late '80s, Japan's domestic real estate bubble was reaching epic proportions.

The Bank of Japan finally pricked the bubble in 1990 and real estate prices fell for 14 straight years. By 2001, some Tokyo properties had fallen 90 percent from their 1989-90 peak prices, an even more dramatic real estate bust than during the Great Depression.

And the carnage wasn't limited to real estate. More than 80 percent of bank loans to corporations were backed by real estate. The lengthy bear market in property prices led to a wave of corporate bankruptcies.

Banks, overburdened by non-performing loans, stopped lending. The financial system was sick and Japan's economy grew at the slowest pace of any industrialized country between 1990 and 2003.

Stocks also got hit. From a 1989 high of nearly 40,000, the Nikkei traded well under 8,000 in 2003, a decline of about 80 percent.

But the decline in Japanese stocks was by no means even-handed. The so-called export blue chips continued to succeed abroad because these companies rely chiefly on demand from the US and Europe.

Japan's domestic market is a relatively small piece of the revenue pie. And the property development firms that performed so well in the salad days of the '80s faced their comeuppance in the '90s.

But the tide has finally turned in Tokyo. Junichiro Koizumi was elected prime minister in 2001 with an aggressive reform agenda. The government forced Japanese banks to write down their bad real estate loans and force the bankruptcy of struggling firms. Koizumi forcefully closed down or nationalized banks that didn't comply with regulations. The result: Japanese banks are now healthier than they've been in years.

The Koizumi government has also used tax incentives to force companies to write down the asset values of their real estate holdings. And in 2003 the government eased estate tax burdens for property transfers—it's now cheaper for parents and grandparents to leave a house or some land to the next generation.

In September 2003, property prices started rising—that was the first up-tick in prices since 1990. During the past year that real estate recovery has spread to other parts of Japan—the long real estate bear market is over.

While the export blue chips are in fine shape, a recovery in the Japanese economy will do little to help the likes of Toyota and Sony.

The biggest beneficiaries of the turn will be banks and real estate stocks.

They're still trading at depressed valuations and will see dramatic gains in the next few years as investors recognize that the big bust in Japan's domestic economy is complete.

The Picks

The bank that's gone the furthest in reforming its operations is Mitsubishi Tokyo Financial Group (NYSE: MTF). The company formed when the government encouraged—some might say coerced—a number of large Japanese banks to merge through a series of deals in the '90s.

After the bank's final merger deal in 2000, management got to work, shuttering an unprofitable California operation, laying off workers and cutting costs.

And Mitsubishi Tokyo was the most aggressive of the major Japanese banks in writing down bad loans and boosting capital. By early 2004, the bank had far and away the largest capital adequacy ratio—a measure of financial stability—among the larger Japanese financials.

Now that the bank's financial house is in order, it's focused on expansion and growth at home. Recently Mitsubishi purchased ACOM, a leading domestic consumer lender.

This is a highly attractive business in Japan; the average interest rate charged on a Japanese credit card is around 20 percent, while bad loans remain minimal, running around 6 to 7 percent of the total amount lent.

Even better, consumer credit is a relatively new phenomenon in Japan compared to other developed nations so growth is promising. Buy Mitsubishi Tokyo below 10.50.

Millea Holdings (NSDQ: MLEA) is Japan's largest non-life insurance company. To combat slowing growth in basic property and casualty insurance products in recent years, Millea expanded into retirement and annuity products aimed at corporate clients.

Retirement funds similar to 401 (k) plans in the US are a relatively new business in Japan. Millea is already ahead of the competition and has signed up the largest number of corporate clients. Buy Millea below 15.

Sekisui House (OTC: SKHSY) is Japan's largest builder and seller of houses and condominiums. While many real estate companies ended up bankrupt post-bubble, Sekisui cut costs and rode out the storms.

Now that business is getting better, Sekisui has been aggressive, teaming up with Daiwa Capital to form a mortgage lending operation.

We also like its recent focus on smaller condominium units in the Tokyo area. Tokyo-area real estate was the first to start recovering in 2003, and it's now showing the fastest pricing growth. Sekisui has stepped up its marketing and sales force in the region to boost sales in this firming environment. Buy Sekisui House under 11.50.

Elliott Gue will be available for questions until Monday, February 21. Don't miss this chance to ask your questions using the below form.