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Japan bull runs out of steam

Japan has been a source of good profits for investors in the past year.

But it has all come crashing down again in the latest of many

disappointments for investors, who have waited 10 years for Japan&#39s

stockmarket to recover.

One wonders how long it will take for the Nikkei to get back up to 39,000,

the level reached at the height of the late 1980s bubble. Now standing at

just over 16,000, having been around 21,000 in early April, the Nikkei

still has the potential to surprise us. But right now, we are once again

looking for signs of a rally to bolster the view that the much hyped New

Japan story has some substance.

The optimistic view is that Japan is in the second year of a bull run

resulting from a change in corporate behaviour. The cancellation of

cross-shareholdings, better allocation of manpower due to restructuring and

the growth of the internet are key positives for the market overall.

The other key issue is liquidity, where two events look set to bolster the

equity market. First, the expiry of postal savings this year is expected to

become a dominant theme as investors seek returns higher than the derisory

amount available from their postal accounts.

Second, the launch in 2001 of the Japanese equivalent of the US 401(k)

pension plan will bring a regular flow of money into the equity market.

The optimist sees Japan&#39s market doubling in the next year and moving

heavenwards from there. But this view has become discredited. Indeed, for

some, it never stacked up.

It will be no surprise to anyone if the pension initiative is further

delayed into 2002. Tim Orchard at Tokyo-based Merrill Lynch Mercury treats

with extreme scepticism the view that the Japanese economy is recovering.

He says while consumption drives over 60 per cent of GDP, there is no

reason to assumeit will provide a significant boost to the economy this

year. As a result, he refuses to participate in the optimism surrounding

value sectors that simply do not deserve to be rerated.

He is equally unimpressed by the prospects for the equity market for 2000.

Sentiment is poor – foreign buyers have begun to exit and domestic

investors, who participated str-ongly, have again been burned.

The behaviour of the new corporate bosses has also proved to be the same

as that of the old bosses. The second-quarter earnings provided by Hikari

Tsushin, one of the new Japan stars, were a massive disappointment to

investors.

The saga surrounding the announcement involved the company owner&#39s

decision to liquidate gains made in the venture capital division to meet

the earnings-per-share target. Unfortunately, he failed to appreciate the

impact of implying a profit but delivering a loss.

From any perspective, the handling of the issue has been insensitive and

is a major factor in the huge retrenchment of the New Japan stocks. Now,

with world markets in turmoil and the prospect of economic slowdown in the

US, Japan is vulnerable to external shocks, which would also have a

negative impact for the rest of Asia.

James Smith, of the Princeton Economics Institute, suggests if the US

catches a cold, Japan will contract pneumonia.

Before the Asian currency crisis, more of Japan&#39s exports were going to

South-east Asia, giving greater balance to Japan&#39s export drive. After the

Asian crisis, the US market has become all the more critical to Japan&#39s

economy. Japan&#39s continuing poor public finances, rising fiscal deficits

and weak growth relative to the rest of the world are clear negatives for

the yen.

Dresdner RCM chief Asian economist Andrew Hunt notes that the fall in the

yen and severe weakness in the Australasian currencies are significant

since these only tend to fall together during times of Japanese economic

weakness.

He says: “It occurs to us that just as the world is now starting to expect

a Japanese economic recovery, Japan is about to disappoint by producing an

underlying deceleration in actual spending.

“The monetary implications of fiscal tightening are already having an

impact on liquidity growth and the double whammy for the equity market

could be both disappointing growth and a tighter than expected liquidity

environment. The fiscal tightening may also undermine the yen, at least in

the short term. This would suggest that investors should be at most neutral

and possibly underweight in Japan.”

The investment implications of the moderation in Japan do not end in Japan.

Japan is the marginal supplier of savings to the world and in normal

circumstances it is the economic locomotive for the Pacific region.

Hunt says: “Between 1986 and 1990, the combined impacts of a strong yen

and strong Japanese domestic demand were hugely positive for the rest of

the Asian region.

“Asian exports boomed, capital flows flooded into the region and Asia was

able to industrialise extremely rapidly. These same factors came together

in 1993-95 with the same result, at least until the yen fell and Japanese

demand withered in 1997/98.

“The result of this reversal was the Asian crisis. In 1999, both the yen

and Japan recovered and Asia once again benefited handsomely. The out-look

for the yen and for Japanese domestic demand is therefore crucial for

Asia.”

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