J@pan Inc Magazine Presents:
M O N E Y W A T C H
Weekly Financial Commentary from Tokyo
Issue No. 68
Tuesday, March 16, 2004
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++ Viewpoint: US Market Correction Comes at Delicate Time for Japan
The Bottom Line:
o Nasdaq and other US indexes have taken a nasty tumble just as
investors were getting bullish on Japan. Ironically, the
dollar痴 rally seems to have had the opposite effect on US
stocks, as investors question the sustainability of a US
recovery that cannot produce job growth. Money Watch痴 view is
that the US correction is not the end to the rebound bull
market, but merely a process by which investors adjust
expectations closer to what is really achievable in terms of
US economic and profit growth, especially given rich market
o Whether the US market correction is merely a speed adjustment
or the prelude to a major sell-off is important to Japan. For
one, foreign investors have been the major source of buying
demand for Japanese stocks and have provided a significant
degree of confidence for Japanese investors regarding their
own economy and stock market. If foreign investors bolt
because of an extended sell-off in US stocks, domestic
investors could well revert back to an overly bearish view of
their own economy and stocks.
o However, if the US economic recovery remains in place, a
waffling US market will actually be positive for Japanese
stocks as foreign investors continue to diversify away from
under-performing US stocks into better performing global
markets, including Japan痴. Indeed, the massive amount of
foreign buying of Japanese equities so far this year is more
indicative of a diversification away from a weak US dollar,
relative underperformance of US stocks and increasing
confidence in the sustainability of Japan痴 economic recovery.
o The US market correction is coming at a delicate time for
Japanese investors, who are currently in the process of
closing their books on the fiscal year through March and
putting together their asset allocation plans for the fiscal
year beginning on April 1. Assuming there is no major shift in
sentiment regarding the sustainability of the US economic
recovery, Money Watch expects that the next wave of buying of
Japanese equities will come from domestic institutions, as
they re-allocate funds from currently heavy weightings in
bonds to equities, ostensibly during the April-June quarter.
o If this is the case, expect the next leg of the rally to
essentially lift all boats in terms of individual sectors and
stocks. This is because most of the domestic pension money is
either officially indexed or "closet" indexed to the Topix.
While large new issues of NTT, Japan Tobacco and others loom
on the horizon, these capital calls should not present too
serious a burden on the market, assuming more active
participation by domestic institutions.
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++ Viewpoint: US Market Correction Comes at Delicate Time for Japan
The dollar痴 rise in the midst of ongoing terror fears highlights its
technically positive prospects. Everyone was short the dollar. Now,
they are not so sure. The quarterly US current account deficit fell to
$127.5 billion in the fourth quarter, defying expectations of a
deterioration to $136 billion, and while the trade gap is up to 4.6
percent of GDP, the recent ballooning foreign inflows into US
treasuries have eased fears of a drying up of foreign financing of the
deficit. Perhaps the monumental breakout in the CRB index this year
has something to do with it? The Institute for Supply Management's
indexes of prices paid and supplier deliveries both rose to nine-year
highs of 81.5 and 62.1, respectively, in February. The last time these
gauges were that high, the federal funds rate was 5.5 to 6.0 percent,
but the weak jobs reports have deflated a lot of expectations for rate
hikes in Fed Fund futures.
The flip side of the dollar痴 recent rise has been a sell-off in the
price of gold, which has fallen some 10 percent from the beginning of
2004. Future prices of other industrial metals have also fallen nearly
10 percent from recent highs -- more evidence of the "shock" that the
weak jobs reports have had on inflationary expectations in the US.
Gold appears to see strong physical buying on any sustained weakness
down to key support in the $390 area, while it continues to hit
resistance at $406. However, copper continues to see a strong drawdown
of above-ground supply, and along with nickel, cobalt and even
uranium, could see a supply squeeze not seen in the modern era if the
recovery is indeed sustainable.
Reflecting the drop in expectations for inflation and growth, Nasdaq
has taken its first nasty tumble since the rally began from 1,108.49
in the third quarter of 2002. With the 200-day moving average still at
1,876, the Nasdaq could fall another 5 percent before stabilizing. The
bears claim that this economic "recovery" is not for real and cannot
create the jobs and real economic activity needed to produce a
sustainable equity rally. Money Watch believes that market
expectations merely got ahead of reality and that the current Nasdaq
correction is more likely a speed adjustment as slower-than-usual
economic fundamentals -- particularly employment -- catch up.
The close correlation that had developed between US bond yields and
Japan's Nikkei 225 since 1997 is indicative of the drag that Japan's
economic malaise and deflation was having on US rates and global stock
markets, at least in terms of financial market perceptions. The
perception persists that Japan痴 economic recovery remains highly
leveraged to exports and to the US economy in particular. There is no
denying that the US economy has been one engine of the global economic
recovery, but the other has been Asia and China in particular. As far
as Japan痴 economic recovery is concerned, however, the real driver
has been Asia and China, as well as an indigenous "digital boom" in
consumer electronics that is helping to boost capital expenditures by
Japanese companies not only overseas but increasingly within Japan.
Although the annualized inflation-adjusted economic growth rate for
the October-December quarter was revised down from the preliminary
figure of 7 to 6.4 percent, the revision was mainly attributable to
increased shipments that caused inventories to be revised downward.
The decrease in inventory was mainly in chip-fabricating devices used
in the production of digital home electronics and related products.
Because the seasonally adjusted figure for industrial shipments logged
growth of 3.9 percent that quarter, the decline in inventory does not
stem from cuts in production due to a worsening economy. Because
shipments increased and inventories declined in the October-December
quarter, there is a good chance that the inventory cycle will
rejuvenate and that there will be a long-term expansion in production.
In addition, the Japanese economy is being energized by an emerging
digital boom. Year-on-year sales of DVD players and other related
devices have been growing at a rate of 60 percent since August 2003,
according to the Nippon Electric Big-Stores Association. The rising
popularity of digital products has even changed the makeup of
consumers actively spending on electronic goods and services. Last
year, the total amount of cable TV charges paid by households headed
by consumers aged 70 or older soared 33 percent from the previous
This is a different development than was seen during the IT boom that
began in early 1999. Then, companies pouring money into setting up
online networks boosted the domestic economy, but domestic hardware
makers benefited little from this, as US manufacturers dominated the
computer hardware field. The economic boom was the shortest since the
end of World War II as a slowing US economy dashed hopes of a
sustainable Japanese recovery driven by an IT "revolution."
This time, Japan痴 economy is being supported by the vigorous
production activity of domestic manufacturers, which has resulted in a
significant increase in domestic capital investment as domestic plants
ramp up production of leading-edge products Japanese manufacturers are
loath to produce overseas. For example, sales of semiconductor
production equipment in Japan surpassed those in the US for the first
time in seven years and are now the highest in the world. Indeed, the
current economic expansion, which started in January 2002, has already
outlasted the previous truncated but more intense IT boom. Component
makers, having learned a bitter lesson from the IT bust, are taking a
cautious approach with regard to capital investment, which means the
supply-demand balance in the parts market seems unlikely to
deteriorate substantially from a ramp-up of new capacity just as an
economic downturn is developing.
If manufacturers can manage to make inroads into the US, Europe and
Asian markets after tapping domestic demand for the new breed of
upscale home electronics products, the current boom could prove
durable, even if corporate earnings do not spike as much compared with
the previous round of economic expansion.
In addition, Japanese companies are just now learning how to tap the
consumption demand from its new active seniors, who are more
interested in spending time and money on themselves than on their
children or grandchildren, a significant divergence from the common
stereotype of nursing-home-ridden, gateball-playing seniors. The
survey found that many elderly consumers defy the common marketing
The Nikkei Marketing Journal recently surveyed a total of 1,379 people
in this group. The active seniors group has sizable disposable income,
helped by having paid off their mortgages, independent children,
retirement allowances and pension eligibility. Around 28 percent of
households had assets totaling 50 million to 100 million yen, and 12
percent had 100 million yen or more. Roughly 38 percent of households
had savings of at least 20 million yen.
This age group represents 12.4 percent of the population, or 15.78
million people in Japan. In 10 years, this number is expected to
increase 21 percent. Compared with when they were in their 50s, 56
percent of those polled indicated that their personal enjoyment had
increased, and 87 percent noted that they had regular hobbies. The
respondents had more than seven hobbies on average, with nearly 40
percent saying their favorite hobbies included walking, jogging,
gardening, listening to music, gourmet tours and watching movies. Of
the respondents, 64 percent called travel a hobby; about 70 percent
took two or more domestic trips in 2003, with 69 percent traveling
overseas in the past three years. These active seniors are also
high-tech savvy. When asked what they desired most, domestic trips,
high-definition TVs, computers and home remodeling were among the most
popular choices. Nearly half the respondents said they used personal
computers or cellphones to keep in contact with friends or conduct
online searches, with 25 percent frequently using email and 27 percent
often using the Internet for research purposes. About half of the
respondents have taken classes to gain computer literacy. Moreover,
these people do not consider themselves "seniors."
While the survey indicated that people in their 60s have a strong
appetite for spending, 74 percent replied that they had never
purchased products expressly marketed for seniors. The designs and
colors of such products are too subdued, indicated 71 percent of the
respondents. Some 87 percent said they still feel relatively young.
"Watching mother-daughter pairs in our stores," said a representative
of women痴 clothing retailer Shimamura, "you can see their fashion
tastes are completely the same." Moreover, these seniors have diverse
tastes and are not beholden to big brand names. Japan's economy is
recovering steadily, but the sustainability of the recovery depends on
how improvements in corporate profits and sentiment can be translated
into consumer spending. In this regard, Japan痴 seniors are positioned
to play a key role.
For the time being, however, there is increasing evidence that
improving sentiment is leading to increased personal consumption.
On March 11, the Bank of Japan apparently decided to raise its
assessment of personal consumption in its next monthly financial and
economic review. Personal consumption expenditures were up 3.4 percent
year on year in January for the third consecutive month of increases.
The total nationwide retail sales index also rose by 2.2 percent year
on year. The Cabinet Office's consumer confidence index rose 0.1 point
in February to 44.4. It marks the second straight month of increase
following a 1.4-point rise in January and a 2.0-point drop in
December. The more evidence there is of a recovery in personal
consumption, the more sustainable Japan痴 economic recovery will be.
For those of us who experienced the Heisei Malaise on a daily basis,
the process has been a long and painful one. Over the past 10 years,
it often seemed that Japan would never be able to come to grips with
serious structural problems without an inevitable "debt deflation"
that purged the massive excesses of the prior bubble from all asset
prices and brought on a classic Schumpeter-like creative destruction
While Japan痴 structural problems are by no means completely solved,
Money Watch believes it is now time to recognize the positive outcomes
that have resulted from Japan痴 decade-long "financial crisis." Prime
Minister Ryutaro Hashimoto first outlined Japan痴 "Big Bang" package
of reforms in November 1996. However, it was not until April 1998
(after a near meltdown in Japan痴 stock market) that many of Japan's
so-called Big Bang financial reforms officially began. Foreign
exchange controls were lifted, the central bank was made more
independent, and the detailed compartmentalization in the financial
services industry was dismantled to make Japan痴 financial markets
more "free," "fair" and "global." Banks, brokers and insurers were
allowed to enter each others・business domains, while many of the
barriers preventing foreign competition were lifted.
A BBC article at the time said, "While few doubt that the Big Bang
will make the Japanese more competitive in the long-run, it is clear
there will be a painful period of transition first." No truer words
were ever said. Following the "macro shock" of the bursting of the
1980s bubble, Big Bang for Japan痴 financial services sector was an
additional "shock" -- from which many market participants never
recovered. In effect, Japan痴 financial system bore the brunt of the
"macro shock" from the bursting of the bubble. The financial sector
absorbed this shock by eventually selling off or realizing all of the
unrealized profits from property and marketable securities holdings in
their portfolios and by receiving support from the government in the
form of historically low interest rates and liquidity in the form of
tens of trillions of public funds. In the process, operating profits
for all banks imploded from over 45 billion yen to just over 10
billion yen. After nonperforming-loan write-offs, this was the major
reason why the P/E ratio for the whole Japanese market was
In addition, write-offs from mark-to-market valuations by other
companies in the Topix and Japanese benchmark indexes ensured a
depressed level of reported corporate profits. In other words, the
lack of valuation losses on marketable securities and even a modest
improvement in profitability of Japan痴 banking sector to pre-bubble
levels could produce several years of very good profit growth for
aggregate corporate profits, considering that ordinary profits for the
four major banking groups are expected to have swung from 4.2 trillion
yen in deficit the previous year to 670 billion yen in fiscal 2003,
even given that Resona lost 1.2 trillion yen.
Japan's banking minister, Heizo Takenaka, said last week it would be
"very tough" for major banks to cut their bad-loan ratios to half by
March 2005, but that he wants them to do their utmost to achieve the
government target. The minister added that the administration would do
its best to help financial institutions achieve the goal by the end of
next fiscal year. At the same time, it is important for the Financial
Services Agency and the Koizumi administration to keep up the pressure
on not only the banks but other financial institutions as well in
order to free Japan痴 economy from the impediments to growth as
presented by excessive debt and weak balance sheets.
Overall, there was a net 717.8 billion-yen capital inflow into Japan
in February, according to preliminary Finance Ministry data. This
buying continued in March, as foreign investors last week bought a
record net amount of Japanese shares amid growing optimism over
the outlook for the Tokyo stock market. The ministry data showed that
foreigners bought 1.032 trillion yen of Japanese shares on a net basis
in the week of March 1-5, the largest weekly net purchase since the
ministry started releasing weekly portfolio flows data in April 2001.
They bought a net 261.9 billion yen the week before. This buying
helped boost Tokyo's benchmark stock indexes to their highest levels
in 21 months. This is because active foreign investor buying has
easily offset continued seasonal selling pressure from Japanese banks
and other domestic institutional investors hoping to lock in profits
ahead of the end of the fiscal year.
Conversely, individual investors sold a record net 528 billion yen of
stocks last week as they rushed to lock in profits amid the run-up. In
addition, trust bank net selling of 310.8 billion yen was at an
historical high for the week.
Continued net buying by foreign investors gives domestic investors a
sense of comfort even as they take profits ahead of the fiscal
year-end. But foreign investors cannot carry Japan痴 market entirely
by themselves, and any sustainable rally will at some point require
more active buying participation by domestic institutions.
Money Watch is assuming that the domestic institutions, after having
positioned their books for their March-end business reports, will be
allocating more funds to equities in the new fiscal year beginning in
April. New allocations to equities by domestic institutions have
traditionally been concentrated in the April-June timeframe and are
just as often the source of higher stock prices during the quarter.
While Nasdaq in the US has recently dipped below its 50-day moving
average and looks set for an extended correction, the Tokyo market has
already successfully tested downside resistance. Aided by a rebounding
dollar as well as record levels of foreign investment, it appears to
have entered its next upleg. While a serious crash on Nasdaq could
derail this rally, Money Watch痴 operating assumption is that the US
correction is more of a speed adjustment in a bull market.
Thus, increased concern about the US market could well continue to
attract additional foreign investor funds to Japan. Active trading by
foreign investors as well as domestic institutions will be needed
particularly over the next six months, as the government readies to
burden the stock market with additional issues of NTT and Japan
Tobacco stock. As long as trading values are in excess of 1 trillion
yen, however, the market is liquid enough to absorb such issues
without seriously impeding the supply-demand balance. In addition,
given that capital expenditures and personal consumption account for
roughly 65 percent of Japan痴 economy, a firmer tone in both can more
than offset any weakness that should develop in net exports.
If domestic institutions do enter the new fiscal year with increased
equity allocations as expected, this wave of domestic institutional
buying could well lift all boats in terms of sectors, because much of
the public-pension money, for example, is either formally indexed or
"closet" indexed to the Topix benchmark. Thus, significant buying by
domestic institutions tends to support all stocks and sectors in the
Topix. Should domestic institutions enter the new fiscal year buying
equities, individual investors -- who are currently taking profits --
are expected to follow.
Consequently, while institutional investors have become more cautious
than ever regarding the US market, continued high expectations for: a)
a weaker dollar, b) more correction in the US market and c) more good
economic news from Japan means Japan has a better than even chance of
decoupling from any extended correction in the US market.
-- Darrel Whitten
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