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2019 marked the conclusion of an incredible decade.

The U.S. started and ended a calendar decade without experiencing a recession … for the first time ever. We saw the creation of 22.6 million jobs, more than any other decade in U.S. history.

And stock investors reaped all the rewards, with the S&P 500 Index surging 195%.

Earnings growth certainly pushed stocks higher. But as the decade progressed, investors became willing to pay higher valuations.

As a result, we now find ourselves with a very expensive stock market. Using expected earnings over the next 12 months, the S&P 500 finished 2019 with a price-to-earnings ratio of 20.2, compared to an average of 16.9 over the past 20 years.

But while U.S. stocks collectively stretched valuations over the past decade, something remarkable was happening across the Pacific.

Despite a 120% rally for the prior 10-year period, stocks in one Asian country have only gotten cheaper. And I see a terrific opportunity for investors. Not only are valuations cheap, but my favorite indicator shows that its economy is about to soar.

Japanese Equities Are About to Surge Higher

As shown in the chart below, the price-to-earnings ratio for Japanese stocks started the decade at 18.5 and ended at 14.9 … exactly the opposite of what we saw in the U.S.

Japan Forward P/E compared to U.S. Forward P/E

But don’t forget, the Nikkei 225 Index still more than doubled during that time. Yet Japanese stocks continue to get a bad rap.

It’s true that the market has yet to attain its prior all-time high … which was set back in 1989. But that doesn’t mean the Japanese economy hasn’t presented tremendous investing opportunities along the way — if you got in at the right time.

And the timing right now is perfect…

One of my favorite leading indicators is showing signs of bottoming.

That indicator? New orders for machine tools. Machine tools are used for cutting metal and fabricating equipment. When factories anticipate growing demand, machine tools for the factory floor are among the first items they need.

Although demand for machine tools has been abysmal — falling nearly 38% compared to last year — there are signs that orders may be picking up again.

That’s because Japan is unleashing a massive $122 billion stimulus package in 2020 to jump-start the economy.

And a U.S.-China phase 1 deal will help revive global trade, a very important factor for Japan’s large export economy.

Once the rate of change in orders improves, there will be big gains for early investors.

Consider the past two cycles of accelerating machine tool orders following a bottom. The Nikkei 225 returned over 30% in each instance, as shown here.

Japan Machine Tools New Order Y/Y & Change

Mark my words: Good times are in store for Japan’s economy, and its stock market will benefit.

You can profit from this trend with the iShares MSCI Japan Small-Cap ETF (NYSE: SCJ). This exchange-traded fund (ETF) provides exposure to Japanese small-cap equities, and nearly 25% is invested in industrial stocks that will benefit from recovering factory demand.

Best regards,

Clint Lee

Research Analyst, The Bauman Letter