After a near 40 per cent rise in the Japanese equity market since it hit its low for the year in mid-May, it seems a good time to review what has changed in Japan.On the fundamental side, the answer is not much. Prime Minister Junichiro Koizumi’s landslide victory had few near-term economic ramifications. Any reform may well suppress rather than stimulate consumption in the first instance. In the meantime, economic data continues to point to a gradual normalisation in economic conditions, with the corporate recovery bringing improved investment in non-manufacturing sectors, positive credit growth for the first time in seven years, a reacceleration of money supply and an ongoing improvement in employment conditions. This normalisation is consistent with our outlook for the economy, which we believe will transcend shorter industrial cycles. But we would emphasise the word gradual. In the latest sign of economic recovery, Japan’s core consumer prices stopped falling in October, raising expectations that the world’s second-biggest economy may be on the verge of ending seven years of deflation. Government bond yields hit 1.63 per cent in November -the highest level in a year – before retreating below the 1.45 per cent level following a spat between the government and the Bank of Japan on the timing of interest rate hikes. November’s economic releases acted as a good illustration of how Japan’s economy is developing. Data revealed that the economy has expanded at a faster-than-expected pace in the third quarter, boosted by domestic demand. Gross domestic product rose by 0.4 per cent in the three months to September, bringing the growth rate for the year to 1.7 per cent, well above forecasts of 1 per cent. A Nikkei survey suggests that major company bonuses will rise by 5.3 per cent, the biggest increase in 15 years, and housing starts rose by 9.1 per cent, the highest level in eight years. After a few months of breakneck gains, Japanese equity markets appear to have decoupled and are benefiting from creeping concern over the US economy. Although there has been some disappointment with regards to US equities, it is manifesting itself as revived interest beyond US borders rather than as an aversion to equities as a whole. This is a benign scenario for Japan but not one that can be relied on to continue were the US outlook to deteriorate sharply. Another interesting factor has been the rapid rotation between groups of stocks. That the Nikkei fell to its lowest level against the Topix since calculation began in 1968 was an indication of the domestic bias in share moves over the summer and the distaste with which tech stocks have been regarded. The market capitalisation of the Topix electronics sector fell below the banking sector for the first time since April 1998. This was recently reversed when the more tech- and exporter-heavy Nikkei reversed some of its underperformance versus the Topix. This was spurred by the continued weakness of the yen, which fell towards the 120 level against the dollar. With such big market moves being the product of a series of surges in narrow and rapidly rotating groups of stocks, the rise in equities has been exhilarating. We are pleased that our portfolios are matching the index in months when big gains are being made for investors. We trust that no matter how the market behaves in future, we are stronger for surviving the last six months intact. A degree of caution must now be warranted. That the market will correct is not in much doubt but its timing is difficult to second-guess. We are confident that, however harsh any correction may be, once markets have taken stock, the way ahead will be even more brightly lit.