J@pan Inc Magazine Presents:
M O N E Y W A T C H
Weekly Financial Commentary from Tokyo
Issue No. 21
Tuesday, March 25, 2003
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Viewpoint: LONG WAR OR SHORT, IT'LL BE GOOD FOR STOCKS
The Bottom Line:
o Stock markets around the world, led by the US market, have
been correctly predicting that the Iraq War will be relatively
short and without major disruption to oil supplies or the
global economy. But regardless of whether it is a short war or
a protracted one, history has shown that the onset of war --
distasteful and abhorrent as war is -- usually represents a
"buy" signal for stock markets.
o Investors thus have to figure out what the underlying market
trends were before the "war discounts" and "war premiums"
became embedded in market prices. At the very least, we will
see a continuance of the short-term reversal of fortunes in
the respective financial markets -- i.e., bullish for equities
and the dollar, bearish for bonds, oil and gold. As Warren
Buffett has pointed out, however, "the hangover will likely be
proportional to the binge," which means that the consolidation
in the dollar and the US equity market will continue even
after cessation of the Iraq War. In other words, while the US
market may hit a secular bottom, it could continue trading in
a basically sideways pattern as the dollar consolidates and
stock prices continue to work off the prior secular bull
market "binge." Conversely, the big gains in bonds and
commodities may be behind us, at least for the foreseeable
o The Japanese stock market will take its cue from US equities,
but as Japanese stocks were plagued with some pretty serious
supply-demand factors even before the onset of Iraq
hostilities and saber-rattling by North Korea, the rally here
is expected to be much more muted, as has been the case
heretofore. The first requirement of a rally in the Japanese
market is decreasing selling pressure on the bank stocks,
which have been a heavy drag on Topix. Moreover, as Topix and
the Nikkei index will be sluggish on the upside, it is better
to play any Japan rally by holding a high beta stock that has
larger market capitalization and has good market liquidity.
Nomura Securities (code: 8604) seems to fit these criteria.
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LONG WAR OR SHORT, IT'LL BE GOOD FOR STOCKS
Stanford University economics professors Eric Zitzewitz and Justin
Wolfers gauged how a looming war was responsible for decreasing the
value of the US stock market and increasing crude oil prices.
econometric study uses as a signal an obscure futures contract (an
unusual derivative contract on Saddam Hussein's presidency that trades
at www.tradesports.com, based in Dublin) that pays off if Iraq's
Saddam Hussein is booted from power. "Almost all of the 15 percent
average effect of war on the market is now priced in," Zitzewitz
subsequently told CBS MarketWatch.com. "So from here on, we'd estimate
that the market expects there to be a 70 percent chance that war goes
well, and the market rallies by zero to 15 percent, and a 30 percent
chance that something bad happens and it falls, potentially by more
than 15 percent."
The professors correctly point out that markets in general reflect
more wisdom than any single person can possibly have, and thus do a
better job of assessing probabilities. Thus the markets are extremely
sensitive to changes in the probability that the war will be short and
relatively harmless to world oil supplies or to the world economies.
But global financial markets have had plenty of time to digest the
potential negatives, and as soon as the fighting actually began, stock
markets began to rally. The famous quote by Baron Rothschild in 1815
("The time to buy is when blood is running in the streets") conjures
up the image of a cynical, heartless capitalist who profits on others'
misfortune, but as regards investing, it is still true today. While
war is costly to wages, disruptive to economies and tragic in terms of
lives lost, the experience of the 20th century (and centuries prior,
as the quote suggests) is that war represents a stock-buying
opportunity. War has not, in the past, dampened the stock market for
long, if at all. As with other crises, the stock market rebounded from
the adversity of war to rise again.
Consider World War I. This war took everyone by surprise. An act of
terrorism quickly snowballed into a war that nobody wanted. Given how
quickly the world went from relative peace to all-out war, you'd
expect the US market to fall, and it did. In 1915, the S&P was down 10
percent, but then rebounded 25 percent in 1916, 3 percent in 1917, 25
percent in 1918, 9 percent in 1919 and 12 percent in 1920.
During World War II, in the five months following Pearl Harbor, the US
market declined by 17 percent, but then gained 13 percent from January
1942 to January 1943, and doubled by 1946. Again, the outbreak of war
represented a low point for stocks from which significant gains were
subsequently made, even though the US spent more than $2 trillion in
current dollars on World War II.
The Vietnam War was the longest war in US history and deeply divided
the nation as the extended conflict took more and more lives. It cost
the US over $400 billion in current dollars, and after the war, the US
market hit the bear market of 1974.
During the Gulf War, the US market declined 13 percent in the three
months after Saddam invaded Kuwait in August 1990. The US attacked
Iraqi forces on January 15, 1991, and by February 13, victory was
apparent. The S&P gained 16 percent and was above its August 1990
level. From January 1991 to January 1992, the market gained 28
percent. The cost of Desert Storm was more than $80 billion in today's
dollars, but some 88 percent of the cost was born by the alliance
coalition. At any rate, the figures weren't large enough to hit the US
Cool-Headed Trading Logic
Because of America's debilitating experience with the Vietnam War
(which the US lost), the preamble to each conflict thereafter has been
shadowed by the specter of Vietnam. The liberation of Kuwait in 1991
by a US-led coalition clearly showed the overwhelming superiority of
the US military over Third World nations such as Iraq. Moreover, since
the first Iraq war, the US has had commanding control of Iraqi
airspace through the enforcement of the no-fly zone. During the first
conflict with Iraq, Iraq still had much of its scud missiles and
chemical weapons intact, as well as a much larger standing army. The
US military has learned from that experience and has also further
developed and incorporated new technologies oriented toward that sort
of warfare. In other words, there should have been no doubt about the
outcome of the armed conflict from the onset. The only question was
how much time it would take and what the political as well as economic
repercussions would be.
Consequently, it is not surprising that the markets (logically
discounting a superior US-led military force and balancing this with
the potential negatives of oil supply interruptions or a significant
deterioration in the political stability of the region) began to
"discount" the possibility of a relatively smooth and short victory
once the fighting actually began. The stock markets had already
discounted as much as a 30 percent "war discount," while a similar
"premium" had long ago been incorporated in oil and gold prices. Thus
the strong rally in stock markets seen over the past week or so is a
classic case of "sell the rumor, buy the fact." It began, as usual,
with traders closing or reversing their short and long "bets" on
various markets, i.e., reducing or clearing short positions in stocks
and the dollar, and reducing or clear long positions in bonds, oil and
gold. The clearing of these positions alone is enough to cause a
short-term stock market rally, and a noticeable sell-off in oil
prices, treasuries and gold.
The financial markets are currently in the process of reversing the
premiums and discounts that were incorporated into financial markets
during the buildup of the Iraq War. The Dow Jones industrial average
is now up 13 percent from a low of 7,524 set on March 11 in surging
for the 8th day, recording its biggest weekly surge in 20 years, and
the effect is global. The German and French markets are up over 20
percent from March 13. Ten-year US treasuries saw their biggest weekly
drop since 2001. Gold and oil prices are falling just as rapidly.
While the Iraq War is far from over and the final repercussions still
unknown, traders and investors in the financial markets have clearly
made up their mind that the conflict will not have a significantly
Thus the real question is what direction the markets take after the
war. The most reasonable assumption is that the financial markets will
resume whatever underlying trend they were in before investors started
discounting the war. Will the dollar continue to depreciate against
other major currencies? Is the biggest weekly rally seen in the Dow
Jones index in 20 years a signal that the US bear market is over? Does
this signal a secular bottom for tech, media and telecom stocks?
Basically, the sectors that have been rallying the strongest of late
are those sectors generally believed to be the most negatively
affected by war -- lodging, transportation, airlines and
basic-materials companies like chemicals. But year to date, life has
been seen in Internet services and semiconductors, both up over 15
percent. The first test of the upside for the Dow Jones comes around
8,600, or around the 200-day moving average, versus the 8,522 close on
Friday. The Nasdaq has managed to close above its 200-day moving
average. The last bear-market rally took the Dow Jones from just over
7,000 to above 9,000, representing a 27-percent rally, but the Dow
failed to penetrate its 200-day moving average, which was still
If the cessation of military conflict is soon, ostensibly with the
early removal of the regime of Saddam Hussein, and geopolitical
repercussions are contained, the pall over global equity markets
following 9/11 from terrorism and the threat of armed conflict could
lift, boosting US confidence in the future and possibly boosting US
economic growth. The reversal of oil prices in turn would dampen
recently inflationary pressures from rising oil prices. In other
words, we could see a secular bottom beginning to form in the US
market following a three-year bear market after the peak of the bubble
in early 2000. But Warren Buffett has recently warned, "Unfortunately,
the hangover from (the bubble) may prove to be proportional to the
binge." In other words, while the US market may hit a secular bottom,
it could continue trading in a basically sideways pattern as the
dollar consolidates and stock prices continue to work off the prior
secular bull market "binge." Conversely, the big gains in bonds and
commodities could be behind us, at least for the foreseeable future.
Japan Markets to Take Their Cue from US
As debate about what to do with Iraq heated up in the United Nations,
tensions with North Korea were escalating. The CIA and Pentagon warned
the Japanese government of the possibility of a North Korean sarin gas
attack and urged it to prepare for such an attack. This risk, combined
with uncertainties regarding the economic impact of a protracted Iraq
War, also created a "war discount" for Japanese equities. This is part
of the reason the Japanese market's response to the good news coming
from the US market has been more muted. A confirmation that the war in
Iraq will be relatively short will cause the Japanese markets to
breathe a collective sigh of relief and could boost stock prices
further, particularly as the internal selling pressure abates after
the end of the current financial year.
In addition, the US invasion of Iraq, regardless of whether it was
justifiable or not, sends a very strong signal to the regime in North
Korea. Once Saddam Hussein's government topples, North Korea could
well think twice about lobbing a Tepo Dong missile over Japan just to
gain attention. In other words, a convincing victory in Iraq could
very well work to reduce tensions with North Korea and the perceived
threat to Japan, thereby helping to alleviate the "North Korean
discount" on the Japanese market.
All this points to at least an interim bottom in Japanese stock
prices. But whether the market can rally as far as it did in early
2002 remains to be seen. The Japan stock market year to date still has
a defensive bent to it (foodstuffs, utilities, nonferrous and mining
are outperforming) amidst a noticeable sell-off in the aggregate
averages, which have been dragged down not only by the financials
(banks and insurance companies) but by noticeable weakness in
blue-chip stocks, such as in the transportation-equipment sector
because of continued unwinding of cross-holdings by the banks.
The Japanese market will remain hobbled on the upside by:
o Continued unwinding of cross-holdings by financial
institutions and other non-financial companies.
o The selling of pension fund portfolios as corporations return
the Welfare Pension portion of corporate pension funds.
Because of continued structural selling by domestic institutions and
corporations for the above reasons, the upside potential of Japanese
stock prices will be limited, even assuming support from renewed
foreign buying, buying of stocks held by the banks by the Bank of
Japan and the revitalized Equities Purchasing Corp.
Any tradeable rally in the Japanese market will have to start with a
rebound in the bank stocks, which have been dragging down the Topix
for reasons not related to geopolitical tensions and the Iraq War. In
addition, as the Topix and Nikkei aggregates are expected to remain
heavy on the upside, a better way to play any rally in Japanese stocks
would be to simply own a high beta stock that has larger market
capitalization and has good market liquidity. Nomura Securities (8604)
seems to fit these criteria.
-- Darrel Whitten
SECOND ROUNDTABLE ON BRANDING IN JAPAN
Brand Mythology: results-driven strategies to leverage the brand story
Four Seasons Hotel, Tokyo
Wednesday May 28th 2003
Main issues to be discussed:
- Fusion of the brand and business strategy
- Brand management in crisis and recession
- Delivering global brands in foreign markets
- B2B targeted versus consumer sector branding
- Global and local case studies of failure and success
Online registration is available at:
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