Scared that Jay might be right?? Hell, no, don't be! Read the last paragraph..... I hear the pitter-patter of those Japanese feet that Jay talked about earlier....
ft.com
Tokyo turmoil
Japanese equities were the toast of last year. The Nikkei 225 jumped 35 per cent and even that gain understated the true scale of Japan's performance. For perverse reasons, Japan's benchmark index fails to include NTT DoCoMo, Softbank or Hikari Tsushin, three of Japan's biggest and best performing companies. A better measure is the Topix index of all first-section shares which rocketed 57 per cent.
For international investors, the news was even better. During the past 12 months the yen appreciated 9 per cent against the dollar. But going forward, prospects look much less rosy. Japanese equities have been propelled by three engines - hopes of a self-sustaining economic recovery, the restructuring of the bloated corporate sector and the impact of new technologies. All three could splutter this year.
The economy
For the Japanese economy, the 1990s were the lost decade. Growth was dismal, and the little economic expansion was only generated by massive fiscal stimulus programmes. Since August 1992 the government has announced 10 supplementary packages worth a cumulative ¾120,000bn. There had been hopes the two consecutive quarters of growth during the first half of last year indicated the world's second largest economy was finally capable of self-sustaining growth, but the contraction during the three months to September confirmed Japan remains a junkie economy, hooked on injections of government cash.
This is an expensive and ultimately unsustainable habit. Since 1991 the country's gross debt as a proportion of GDP jumped from 60 per cent to 130 per cent. The latest ¾18,000bn package will probably ensure limited growth this year, but it would be foolish to bet equities will benefit from autonomous economic growth any time soon.
Restructuring
This poor macro-economic environment means most Japanese companies continue to struggle to generate top-line sales growth. During the six months to September, the 124 non-financial companies that reported consolidated earnings suffered an average 7.1 per cent year on year fall in sales, although this was exaggerated by a 16 per cent drop in turnover at the trading houses. To drive earnings growth, Japanese corporations must cut costs. Most reductions in headcount are over long periods - typically two to four years. And the targets are to be achieved through cutting graduate recruitment, voluntary early retirement and shifting labour into non-consolidated subsidiaries. So far there has been no question of compulsory redundancies of the type that allowed corporate America to restructure in the 1970s and 1980s.
Japan's labour system is flexible and inflexible. Flexible in the sense that bonuses and overtime can be reduced. Inflexible, because management will do almost anything to protect their male, full-time staff. The brunt is being felt by female and part-time workers, as well as suppliers being squeezed remorselessly. Japanese executives will not bite the bullet on labour costs. Indeed, many continue to view their organisations as country clubs run for their own benefit. The result is that although sales, general and administrative expenses fell a creditable 1.8 per cent in the six months to September, that was far less than the fall in sales.
One bright area of restructuring is mergers and acquisitions activity which reached record levels last year. The industrial electronics conglomerates, in particular, are beginning to restructure their sprawling portfolios of businesses. But despite the uptick in M&A activity, volumes remain tiny compared with the US or even Europe. Moreover, many presidents seem incapable of overcoming opposition from their staff. Investment bankers talk of deals that fall through because of middle management resistance.
The result of this lacklustre restructuring is that despite the aggressive run-up in the Topix, nearly half of stocks on the first section are lower than at the start of last year. Indeed, about 40 per cent of all companies are trading below book value. The market is pricing these companies for extinction. This month even an international brand such as Citizen was trading at a discount to the net cash on its balance sheet.
New technology
With the economy back in the doldrums, and restructuring efforts at best half-hearted, the Topix's impressive performance has been thanks to startling performance by a tiny band of shares. Nearly 60 per cent of the entire capitalisation of the 1,318 companies on the first section is concentrated in just 50 stocks. These nifty 50 are almost entirely in the technology and telecoms sectors.
Japanese investors may have been late embracing the internet age, but they have made up for the delay with subsequent over-enthusiasm. Softbank, the internet investment company which was only listed on the first section in January 1998, saw its shares jump 1,264 per cent last year from ¾6,800 to ¾92,800, giving it a market capitalisation of $95bn, the fifth largest company in Japan. Hikari Tsushin, a mobile phone handset distributor and internet investor, listed on the first section last September. Its shares jumped 2,878 per cent last year from ¾6,950 to ¾207,000. The group now has a market capitalisation of $59.5bn. It is bigger than Honda and Matsushita, though Hikari is expected to generate net profits of just $106m on sales this year of $2.8bn.
The valuations on Japanese internet companies make their US counterparts look like deadbeats. The lack of breadth in the equity market suggests any loss of investor confidence in the internet phenomenon would create a nasty correction.
What forces could keep the market at these levels, or even push it higher? Japan's traditional companies will undoubtedly continue to unveil hidden internet assets which they will endeavour to float. Mergers and acquisitions activity will also accelerate and there is even the possibility of a hostile takeover bid. But most important could be a massive shift of assets from postal savings accounts into equities. Over the next two years, ¾106,000bn of high-yield postal savings will reach maturity, equivalent to 21 per cent of GDP. Even if a small proportion is invested in equities, it would give a considerable impetus to the market. That alone is the best hope for Japanese equities. |
