Flaws in the fabric of the Japanese economy still mar the outlook for equities in the country. But equity strategists are now cautiously optimistic about the prospects for share prices in Japan – at least in comparison to the outlook for equity markets in the US and Europe.
Hopes are springing up that the government will take some steps to loosen fiscal policy, and downwards pressure on prices resulting from banks selling off their crossholdings is likely to abate, they say.
The steep falls seen in global equities markets in recent weeks have rattled Japan, but the direct causes of those falls have not. “It (the Japanese equities market) is very much affected by the global markets,” says Yukiko Kawamoto, head of equities at HSBC Asset Management in Tokyo. “But so far, it has been OK because Japan is free from the structural problems which are currently worrying the US market.”
Shoji Hirakawa, chief Japanese equity strategist at UBS Warburg in Tokyo, points out that Japan has had its own brand of accounting malaise, resulting in many companies each year having to rebase their accounts.
Hirakawa says he expects the Nikkei index to decline in the next few weeks, falling to 9,000 or 8,500 by the end of September. The bulk of the selling will come as a result of the continuing dissolution of crossholdings by Japanese banks, he says, but adds that this pressure will soften somewhat.
In a research report, Goldman Sachs says the pace of crossholdings unwinding in Japan has been slower in the current fiscal year than it was in the 2001 fiscal year. According to stock exchange data, crossholders – banks, insurance companies and corporates – sold just ¥442bn (E3.85bn) of Japanese equities during April to June – roughly half the amount sold during the same period in 2001.
Even though many people might believe that crossholders therefore have a lot of catching up to do – putting more pressure on the market – Goldman Sachs says there are many reasons why unwinding pressure might now be lighter than anticipated.
Also, there are now alternative ways of unwinding. “We believe that a considerable proportion of the recent surge in share buyback announcements (¥8.8trn in April-May alone) will be used to ‘absorb’ potential crossholding un-winding by banks.” And banks are now using newly established vehicles such as ETFs to unwind their cross-holdings.
The market is facing a wave of corporate earnings figures. “I believe earnings will be fine for Japanese companies,” says Kawamoto. “But on the other hand, the major blue chip companies are still dependent on the global economy, so if the US economy slows down there could be some effect on earnings.”
However, with the indices at their current low levels, bargain hunters could emerge to provide a boost. Sectors that catch her interest in particular include basic materials, services including retail and real estate businesses. Some financial services stocks could also be attractive, she says, but not the big banks. “Some tech companies are fine, but this sector is still vulnerable to the US market,” she notes.
Goldman Sachs also favours certain pockets within the hard-hit technology sector. Analysts there said that amid widespread pessimism, they have raised their recommended weighting in Japanese technology – electrical machinery, precisions and IT services – within their model portfolio.
Market players are watching with keen interest to see how the Japanese government pitches its fiscal policy. “The current government has always been emphasising that it is a tightening government, but recently they have changed their course slightly towards an expansionary policy,” says Kawamoto.
Though the legislators are not at all likely to adopt a thoroughly expansionary line, she says there could be another budget in the offing which will provide for bailing out troubled financial institutions. Public spending, on the other hand, continues to be reined in.
Hirakawa says he sees the government sticking to its stance on tight fiscal policy for the near future, adding that this will keep market sentiment weak. However, he predicts that pressure from the market over the next few months will probably result in the government loosening fiscal policy later on, and intervening in the currency markets to curb the yen’s strength.
All of this, he says, will form the catalyst for equity prices to move up, with the Topix hitting 1,200 to 1,300 by the end of the fiscal year next March.
Kawamoto believes that fundamentally, the Japanese economy is moving in the right direction. For the Topix index, she does not expect to see levels at the end of the year to be any lower than they are now. Instead she sees 15% upside, on the basis that earnings forecasts will be achieved, and that price earnings ratios will stand at around 25.
Hirakawa says international investors are continuing to underweight Japan in global portfolios, as bad debts and economic structural problems remain unresolved.
Share prices in Japan are lower than their levels at the start of this year. But Goldman Sachs points out that relative to the rest of the world’s major equity markets, Japan has remained resilient.
“We believe this relative outperformance should continue, supported by improving domestic economic conditions and better than expected supply/demand,” the analysts said. “However, given out concerns about potential earnings disappointments ahead, we believe the market’s upside will be limited.”
The next important indicator, says Goldman Sachs, will be April-June GDP growth figures, which is to be announced in September. They expect a figure of 1.6%.

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