No consensus on Japan
The Japanese equity market has whipsawed like an angry snake this past week as fears that a slow down in export markets will hit large cap manufacturers have combined with the need for stricken institutional investors to increase their liquidity and realise cash. With foreign investors quitting in droves, January’s freefall was only arrested at the end of this week, when Japanese equities recorded their largest one day gain since March 2002.
Paul Sheard, chief global economist at Lehman Brothers, says that Japan has disappointed foreign investors as it has failed to reflate and domestic demand has remained weak: “It is now looking increasingly vulnerable and the question is whether it will slip back into recession even before it has gotten out of its decade-long deflation.”
Japan has long proved a vexatious market, frustrating those who see strong company fundamentals but ultimately failing to fulfil its potential. Between 2003 and 2005, Japan’s economy was driven by export-oriented companies, but then it began a big rally on the expectation that banks, real estate stocks and retailers would benefit from domestic demand growth. “This created a mini-bubble in these stocks which has now brutally come to an end,” says Albert Abehsera, portfolio manager and CIO at IFDC.
Ed Merner, president of the Atlantis Investment Research Corporation, and a long-time resident in Japan, attributes part of the decline to a loss of confidence amongst retail investors caused by the media. Japanese retail investors are the second biggest players in the market, and they have been selling for some time.
“The news of a global economic slowdown has worried people and businesses are losing confidence,” he says. “As the economy has been in a slump or a low growth period for some time now, people are very cautious and bad news frightens them.” Small and mid-cap stocks have no support, but even some of the big stocks are falling very fast, according to Merner: “It’s not a pretty picture and people are very scared.”
This is despite the fact that the fundamentals are not bad, exports remain pretty strong and private capital investments have been pretty good. However, overall sentiment has been affected by a construction housing scandal and poor wage growth. “Many Japanese corporates are using temporary workers more and more to reduce fringe benefits,” says Merner. So even though the Japanese labour market is tight, especially for skilled labour, corporate profit growth hasn’t translated into higher incomes, and consumer demand has remained sluggish.
Market participants who subscribe to the domestic demand-led recovery theory, such as Hideo Shiozumi, manager of Legg Mason’s Japan Equity Fund, believe that there may be increases in monthly salaries this year. But other seasoned Japanese equity managers are more sceptical. Abehsera questions how wages can go up in the current environment if they didn’t during the relatively prosperous period of 2003-2007.
“I am flabbergasted to hear these comments because wages didn’t go up when companies were making money from exports,” he says. “And small companies stopped making money in 2005. They were unable to pass on raw material and oil price increases to their customers and their margins were squeezed. But two-thirds of the Japanese labour force is employed by SMEs.”
He adds that large companies have made money from cost reductions and export growth, but instead of increasing wages they have preferred to reduce debt and pay more dividend, as well as invest in machinery. “With the outlook turning gloomy, they are unlikely to increase wages now. It would be unwise for them to do so at a time when their earnings may be under pressure from lower sales overseas.”
Two stories posted on Thomson IM News this week explore these different views in more detail. But even the less optimistic managers see the current whipsaw market as a chance to hunt for good companies at low valuations. Pascal Masse, head of Japan equities at Aberdeen Asset Managers, says that investors need to shut out the noise and not worry about Japanese politics or the yen versus the dollar. “The main downside risk is a US downturn, and if it impacts Asia it will hurt Japan’s export markets. In the domestic market I see no negative change, in fact, it may actually improve. Japan looks set for much of the same – slow, gradual growth.” The fact that the market bounced back on news of the US stimulus package and strong Asian data, suggests the rollercoaster ride is not over yet.
Access the view from the Japanese bulls here:
http://www.thomsonimnews.com/story.asp?sectioncode=7&storycode=34601
For the more bearish take on the market, click here:
http://www.thomsonimnews.com/story.asp?sectioncode=&storycode=34768
