Should you be investing in Japan? The short answer is yes, unless you believe that Japan will never resolve its economic problems. But don’t expect too much short-term equity market action, as the indices have already shown a good head of steam this year.
Templeton’s chief investment strategist Sandy Nairn puts it like this: “It has to be said that valuations in Japan, if you assume that Japanese companies will eventually compete with their western counterparts, are going to give us value on any decent time horizon. So I anticipate exposure to Japan gradually rising over the next 12 months.”
The increase of foreign buying interest, which has been the biggest (some would say the only) driver of the stock market resurgence, is based on a perception that Japan has turned the corner. So how deep is the restructuring? From a macro-economic standpoint, Japan is still a basket case. There is no growth, the yen has been too strong against the dollar, hurting the export stocks which were the last hope for growth, unemployment is the highest it’s been for 50 years and there is no evidence of an increase in domestic demand.
Progress in structural re-form has moved at a snail’s pace as the economic environment has not become severe enough to force any serious changes. Unlike oth-er crisis economies such as In-donesia or Russia, Japan still has the internal resources to stave off any real economic pain.
Goldman Sachs chief strategist in Tokyo Kathy Matsui agrees: “There’s a lot of money wanting to buy Japan – but there is still a lot of room for disappointment. The pace of restructuring is not keeping up with the pace of deflation. The Nikkei looks relatively firm but the proof of the pudding will come in May and June, when company results are announced and we will see that restructuring hasn’t proceeded as expected.”
One commonly offered prescription for resolving Japan’s debt burden is monetisation, or printing money. If the government does decide to monetise and set inflation targets, this would underpin the continued strength of the stock market. The danger with this strategy is that the Bank of Japan prints money, deflation becomes inflation, as plan-ned, but at the same time, job uncertainty forces consumers to hold on to their cash, which would lead to a worst-case scenario of inflation with no growth, or stagflation.
Curtis Freeze of Tokyo-based Prospect Asset Management believes the market has got ahead of itself. He suggests what gains have been made in the first quarter of 1999 will probably constitute the full extent of the market’s rise this year, especially as there is a lot of bad news to come. The way Richard Cardiff of Fleming sees it, “deciding whether or not to invest in Japan now could well turn out to be one of the most important investment decisions of the decade”. Freeze adds, “It’ll be a turbulent period over the next five years, torn between the good news of the demand from overseas investors, and the bad news of the continuing restructuring.”
As part of the transformation of Japan’s financial sector, via the so-called Big Bang reforms, Japanese banks and insurers are now permitted to offer the public their own unit trusts. The growth potential for the Japanese fund market is enormous, estimated to be worth around ¥44trn (e340bn). Around 60% of the ¥1,200trn in financial assets is in bank accounts yielding less than 0.5%. One only needs to look at the US to see how important the retail funds market has been in underpinning the stockmarket. Long term, local investors will come back to the market and that factor should not be underestimated.
There is a clear contrast between those managers who believe the latest Japan rally is sustainable and those who cannot shake off the feeling that fundamentally very little has changed. Interestingly, the most bearish managers are those based in Tokyo, while those running their portfolios from London, for example, are a good deal more optimistic.
For the first time in probably five years, fund managers are finding a good supply of buying opportunities. Look at those fund managers who have produced outperformance in recent years, the likes of Fleming, Schroder, Invesco GT, Perpetual and Newton. They all have a positive outlook on the markets and a consistency of process and return. They see that pressure has been brought to bear on corporates to improve their return on equity and that this is now bearing fruit.
The level of interest in Japan is in danger of making its stockmarket recovery a self-fulfilling prophecy. The Asian markets, at least those that have come out of their trough, are gaining attention from western investors, including those from the US investors. The other important factor to consider when looking at the performance numbers is the extent to which currency appreciation has distorted the picture. It is important to know what the management group’s policy is regarding hedging and to what extent the good performance it has put on in the past year is a reflection of the currency and what proportion is the fund manager’s stock-picking ability.
Richard Newell is a director of Forsyth Partners

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