Where did the Nikkei's (NIKKEIINDICES:^NI225) gains go? After trouncing markets across the world with its eye-popping start to 2013, the world's third-leading economy has seen its top stock index fall dramatically over the past few weeks. The Nikkei did it again on Thursday, shedding 5.2% after plunging more than 7% in a single day last week. Investors are fretting over the losses, but is this fall something you should be concerned about -- or is this pullback just the dip you need to pick up the best Japanese stocks before another rise comes?
Don't panic...don't panic
Look no further than the yen for Nikkei's drop on Thursday. The U.S. dollar weakened due to fears that the Fed might slow quantitative easing later this year, and a weaker dollar strengthened the yen against the U.S. currency. That's not what Japanese investors wanted: Prime Minister Shinzo Abe's unrivaled stimulus plan promises to kick-start inflation after decades of stagnation. While the yen has dropped dramatically against the dollar in the first half of 2013, the yen's volatility has unnerved some investors.
This isn't the time to sell, however. Volatility is only natural considering how fast and effectively Abe's aggressive monetary plan worked. Abe's new moves already pushed the Nikkei to five-year highs recently, and Japan's currency recently hit 100 yen to the dollar after trading at almost 70 yen to the dollar late last year. That's fast progress -- faster than many had predicted easing would work, and Abe's hardly finished. The Bank of Japan plans to double the country's monetary base, and while U.S. easing may or may not be slowing soon, Japan's certainly won't.
Abe has stuck to a 2% inflation goal as his target for stimulus, and Japan's nowhere near that figure yet. More easing will keep the yen falling against the dollar, regardless of what Ben Bernanke and the Fed have planned for QE infinity.
Ultimately, Japan's stimulus is a long-term project that will include plenty of volatility. Currency prices are prone to fluctuations, and Abe's unprecedented level of easing will cause the yen and Nikkei to soar or dive on small bits of news. Is Thursday's fall a correction after the year's torrid start? Absolutely. Is it a sign that Japan's stimulus isn't working? Not so.
That doesn't mean you should rush headfirst into any old Japanese stock on the hopes of a nationwide surge; as with all investing, picking the best stocks is the way to go. The country's top exporters have seen their stock rise and fall with the yen's volatility, but leading manufacturers such as Kubota (NASDAQOTH:KUBTY) and Komatsu (NASDAQOTH:KMTUY) are poised to ride a weaker yen higher to better compete against foreign rivals.
Komatsu has seen its sales fall in China, where the company leads the manufacturing industry. However, despite China's recent slowdown, Komatsu leadership still sees demand picking up between 5% and 10% in the world's second-largest economy as the Chinese government contemplates its own stimulus plans. The weak yen will mean that Komatsu's sales matter all the more, particularly as top competitor Caterpillar (NYSE:CAT), which has been hammered by the mining industry's decline, ramps up its own China operations. Caterpillar lags Komatsu in China, but it increased its Chinese sales year over year in the first quarter.
Kubota's a beneficiary of the yen as well. In fact, this stock has soared more than 9% in the past month, even after the Nikkei's recent plunge. Kubota is still chasing Deere in the agricultural-manufacturing and tractor industry, but leadership predicts that the yen's slide could push sales to a record high this fiscal year. The weak yen could also hurt the company by making it more costly to invest overseas -- something Kubota is ambitious to do as it looks to acquire firms specializing in making larger tractors.
The yen is set to keep falling
Despite the yen's recent volatility, Japan's currency will not soon strengthen much against the dollar. Shinzo Abe has put his government behind easing, and stimulus has defined his short tenure as prime minister as much as anything else. Quantitative easing may be under fire in the U.S., but it won't be stopping for a long time across the Pacific. Expect more volatility from the Nikkei and the yen, but over the next few years, Japan's best stocks are set to reward investors with superb gains.
Fool contributor Dan Carroll has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.