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Special Report

ESG: The metrics jigsaw


Playing tag with US

Deep-seated domestic economic problems still dog the Japanese market, and strategists says these factors are not going to evaporate just yet. But corporate earnings are improving.
In the absence of major developments on the home front, equity strategists say they expect to see Japanese share prices playing tag to the US market in the next few months.
Stocks in Japan slumped in early April, mainly as a result of technical factors related to the start of a new fiscal year. February and early March traditionally form the strongest period for the Japanese equity market. This is because it is important for bank balance sheets that prices are as high as possible when the fiscal year ends on the last day of March.
But downside from here on is limited, strategists believe. “I think the market has bottomed already in terms of the economic cycle,” says Yukiko Kawamoto, head of equities at HSBC Asset Management in Tokyo. But while the economy may have passed its lowest point, there are still no signs of strength emerging, she adds.
Domestic bad news – bad debts and the government’s failure to respond adequately to the problem – has already been factored into prices, strategists say. Instead, the market is looking to overseas markets for inspiration.
For example, in mid-April, a government report said bad-loan write-offs would be bigger than expected. But this put little pressure on the Nikkei, which instead reacted positively to a higher close on Wall Street.
Although the Nikkei 225 has tipped just below the 11,000 mark in the last few weeks, Nick Read, senior investment manager at Gartmore in Tokyo, notes that 10,000 has always been a support in the past for the index. He predicts the market will remain volatile over the next six months, but stay in a trading range between 10,000 and 12,500.
HSBC is fairly confident that corporate earnings will be favourable this year, says Kawamoto, with cost-cutting measures paying off. Kawamoto describes her market view as mildly optimistic. Stock valuations are not too high currently, and the supply and demand situation in the market is favourable she says. There is some ongoing selling pressure from Japanese banks, however, as they continue to unwind their cross-shareholdings.
However, this year global investors will choose to be less underweight in Japanese equities than they were last year. This time there is no financial crisis in the offing, which means the risk premium is disappearing, she predicts.
Shoji Hirakawa, strategist at UBS Warburg in Tokyo says he expects the currently emerging earnings recovery to last at least one to two years. He advises investors to be in the market before the economy picks up momentum and sustained recovery becomes a reality. We expect TOPIX to continue rising through to mid-May on improving equity market supply-demand,” he said. “Subsequently, a correction is likely, partly due to unwinding of crossholdings, but we still see TOPIX ending the year at 1,400.”
Noel Mills, asset allocation strategist at Barclays Global Investors, says the Japanese economy does seem to be benefiting from the strength of the US-led global recovery.
“In particular, the IT sector is showing signs of life amid a tech-led improvement in regional trade,” he says in a report. This is encouraging, he says, since Japan is heavily dependent on exports to lead the way back to economic growth.
But most recent moves by the government to prop up the economy have failed to convince the markets. Mills says: “The latest ‘anti-deflation’ package is widely seen as a series of palliatives designed to relieve the symptoms rather than tackle the causes of the country’s economic malaise.
“Anything that relieves the pain will make the politicians feel better but could be counterproductive to Japan’s longer-term economic well-being,” he says.
Read says investors had been hoping for an announcement from the government that it would bail out the Japanese banking system. This would have been positive for the market, if not particularly so for bank shareholders, he says.
A major problem for the Japanese economy is the large number of unprofitable companies being sustained by the banks that continue to lend to them. Dubbed ‘zombie companies’, these are mostly in the retail and construction sectors. Banks are not likely to pull the plug on these companies unless such a move is sanctioned by the government. For its part, the government is reluctant to force them into bankcrupty. As they are such large employers, this would be an unpopular political move domestically.
The continued existence of these zombie companies ruins the situation for their competitors, argues Read.
But Prime Minister Koizumi seems to have lost credibility within the party and the government to push real reforms through the legislative process, says Read.
Hirakawa of UBS Warburg points out that Japanese corporates have been paying down debt since 1995, but there is still an estimated 70 trillion yen of excess corporate debt in the system which could take several years to clear.
Kawamoto says the greatest opportunities are still offered by stocks within cyclical sectors, though this emphasis should shift to other areas. The technology sector is expected to outperform, and smaller caps may offer an investment opportunity.

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