Japan's Nikkei 225 index fell to a two and half year low on Tuesday as foreign investors sold blue-chip stocks exposed to growth in Europe and the U.S. One strategist said things are likely to get worse for Japan's major exporters and he recommends investors buy mid-cap companies that depend on domestic growth.
"I'm seeing this with a lot of our clients, a structural move into the mid-caps space," Alistair Fullerton, global head of strategy at brokerage IND-X Securities told CNBC.
"Companies in the tech space, which are cyclicals stocks — the ones who are obviously going to move when the global economic outlook is so dire," he said. "There are going to be some headwinds for the Sonys, the Hondas... and the Canons."
Fullerton recommends mid-cap stocks in social gaming and the retail sector. His top picks include internet company Gree, video game creator Konami and cosmetics firm Dr.Ci:Labo.
"They're [companies] at the moment [that] are not being moved by these offshore headwinds," Fullerton said. "There's no concerns in terms of the rising yen, they're purely providing domestic product, and in doing so, they have significantly outperformed."
Focusing on Japan's domestic growth may not seem like a safe bet given that household spending declined 2.1 percent in July from the previous year, while Japan's GDP contracted 1.3 percent on an annualized basis between the first and the second quarters. But Fullerton believes that Japan's consumer sector has strong balance sheets to face a slowdown.
"I think what you'll find now is the consumer industry is in good order, and the deleveraging has been going on for a number of years," he said.
Another problem, mid-cap stocks don't necessarily come cheap. According to Fullerton, mid-caps trade at 16-times earnings, about the same level as the large-caps. Some of Fullerton's recommendations trade at even higher multiples. Gree, for example, trades at 31-times earnings, and Fullerton concedes that's expensive.
"A number of these gaming stocks are immune to the recession fears, really if you're looking at a sector which is continuing to produce sort of robust growth, you are looking at this gaming space," he said.
Fullerton is bullish on Gree's smartphone games platform, which he said has huge room for expansion in Japan as well as in foreign markets such as China and Southeast Asia.
"You're looking at something resilient that can ride out better than another sector — [the] social media or gaming space is less correlated to the global trend," he added.