Back in April the market was languishing at the same level as two decades earlier. But a rise of 30% to early July led many to reconsider the merits of the Japanese market.
Foreign investors were the main buyers in the rally as the Bank of Japan pumped huge amounts of liquidity into the economy. But it is difficult to discern whether the rise was a one-off or if more fundamental changes are underway.
Michael Thomas, the head of the Japan team at Martin Currie, is perhaps the m
ost precise in his predictions of a Japanese market revival. He has publicly stated that the market is set to rise by 30-50% over the next two years. Many other Japan fund managers have also expressed optimistic views although they have generally shied away from being so specific.
Sustained rise
Of course it does not necessarily follow that because optimistic predictions have proved wrong in the past that hopes will necessarily be dashed this time. The key question is whether there are new trends emerging which will lead to a sustained rise at least for sections of the market.
It is important to emphasise that the optimists’ case is not based on a strong resurgence of the Japanese economy. No serious analyst is predicting that there will be a return to the days when it was easily the strongest performer of the world’s large economies.
Having said that many Japan specialists argue, with some justification, that foreigners tend to overestimate the extent of Japan’s economic demise. For example, Sarah Whitley, the head of Japanese equities at Baillie Gifford, emphasises that Japan still has the second largest economy in the world. She also points out that the economy has grown in all but two years since the market collapsed in 1989 and that personal consumption has grown every year.
But the optimists’ case is based on a variety of factors rather than a belief in an overall economic revival. What they share is a conviction that they can benefit from broader trends rather than restricting their portfolios to a few internationally competitive Japanese companies. Different analysts emphasise different themes but there are several key arguments that are preoccupying those involved in the market:
Deflation grappling
* The Japanese authorities are finally getting serious about grappling with deflation.
Jesper Koll, the chief Japan analyst at Merrill Lynch Japan, has argued in the Wall Street Journal that this trend is clear in three main areas: banking, foreign exchange and monetary policy. In relation to banking the effective nationalisation of Resona, the country’s fifth largest bank, in May removed fears of a credit crunch. On foreign exchange the fall of the yen against the euro should help to bolster exports. And, since Toshihiko Fukui took over as the governor in March, the Bank of Japan has rapidly accelerated money supply growth.
The combination of all these elements should give a big boost to the Japanese economy. In addition, there is the possibility of an increase in public spending which should stimulate the economy still more.
* Japanese management is shifting its focus. Many specialists in Japan are arguing that Japanese management is finally shifting towards making profits from its old priority of maximising market share. As a result the Japanese corporate sector is becoming more attractive to shareholders.
From this perspective a number of key indicators are being welcomed by fund managers. The rise in the number of bankruptcies and unemployment are in many ways positive signs. They show that unproductive capacity will be closed down and firms are willing to restructure.
The increasing flexibility of the labour market also provides some direct benefit for fund managers. For instance, Goodwill, a company which provides other firms with temporary workers, is particularly popular among investors.
Demand balance
* The balance between the supply and demand for shares is improving. Over the past few years the unwinding of “keiretsu” – networks in which groups of Japanese companies hold each other’s shares - has artificially bolstered supply. But now that many firms have surplus cash on their balance sheets they are often buying back their own shares rather than selling their holdings in related companies.
* Property prices are stabilising. The stabilisation of the real estate market after many years of falls is a particularly welcome sign to Japanese investors. One of the main reasons for the bad debt problem was that property was often used as collateral for loans in Japan. So when property prices fell, as they did from 1989 onwards, the bad debt problem intensified. This situation now shows signs of going into reverse at least in some parts of the country.
* Share valuations are reasonable. Japanese shares were often expensive relative to their international peers. But now they are priced at a relatively attractive level.
* Japan will benefit from the rise of China. The optimists say a strong symbiotic relationship is emerging between Japan and China. Japanese firms should gain from the rise of a huge new market for their goods. In addition, many Japanese companies are investing in China to take advantage of the vast pool of cheap labour.
For example, Kerry Goh, a Japan fund manager at Govett, argues that Japanese firms should benefit from the emergence of a huge car market in China – already the fourth largest market in the world. Yet, given the huge size of the Chinese population, there is still scope for spectacular growth. Japanese firms are likely to make the engines, chassis and other key components. Chinese producers will assemble the components and sell the cars in China.
Question revival
Whether all of these factors will lead to the anticipated Japanese market revival is open to question. Even if all these trends are underway it is hard to gauge their extent or to predict their exact impact. For instance, China may prove more of a competitor to Japanese firms than the optimists are predicting.
In addition many of the old problems still remain. The corporate sector is saddled with huge amounts of bad debt. Banks have massive portfolios of non-performing loans. Falling consumer prices create a disincentive to spend. And the political reform process is painfully slow.
For investors the question is whether the shift in corporate Japan is enough to sustain a market recovery. The Japanese market, although often forgotten, is too important for investors to ignore.
