J@pan Inc Magazine Presents:
M O N E Y W A T C H
Weekly Financial Commentary from Tokyo
Issue No. 71
Tuesday, April 6, 2004
@@ VIEWPOINT: The Fed Fixates on Jobs while the BOJ Focuses on Prices
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@@ VIEWPOINT: The Fed Fixates on Jobs while the BOJ Focuses on Prices
The Bottom Line:
o The US economy pulled a hat trick on Friday, producing the
fastest pace in payrolls in nearly four years for March. It
was possibly the best economic news since the onset of the
last recession in 2001 and a sign of spring for the nation's
labor market, which has been mired in its longest slump since
1939. Job growth acceleration means a stronger US economy and
higher interest rates, and implies a recovery in the dollar.
Bonds, however, will not be waiting for confirmation by the
Federal Reserve, nor will commodity prices. Bond investors and
commodity traders are therefore likely to have already made up
their mind about the economy and what the Fed will do well
before it actually moves to tighten US monetary policy. More
strong job reports will boost stocks, boost bond yields and
hurt commodity prices, while weaker job reports will help
bonds and commodities at the expense of equities.
o As outlined in previous market letters, we subscribe to the
scenario that the US market correction was merely a speed
adjustment, and the US market's bounce on the good job news
appears to bear this out. Nasdaq and US equities continue to
maintain a positive bias.
o The outlook for Japan and Japanese equities was also boosted
by an upbeat Bank of Japan (BOJ) tankan business sentiment
report. The diffusion index for large companies in the
non-manufacturing sector posted the highest figure since May
1992, and business confidence among smaller firms has also
improved. In other words, Japan's recovery continues to
broaden and deepen. While there is some speculation that the
BOJ could move before the Fed in lifting its zero-interest-
rate policy, the BOJ is not keying on jobs or economic
strength per se, but on prices in the form of the consumer
price index (CPI). The BOJ continues to insist that it will
not move until the core consumer price index, which excludes
volatile fresh food prices, shows at least low inflation for a
sustained period, and the BOJ is convinced prices are unlikely
to fall back.
o So while the Fed is keying on sustainable job growth as the
trigger for its shift in monetary policy gears, and the BOJ is
keying on the CPI and the emergence of inflationary
expectations as the trigger for its abandonment of the
zero-interest policy, the impending shift of monetary policy
gears for both does not appear imminent. This gives both US
and Japanese equity markets a grace period as the US economy
plays catch up in terms of producing job growth, while budding
inflationary expectations in the Japanese economy are given
time to diffuse further and completely eradicate lingering
deflation. This is good news for both the US and Japanese
equity markets, as a shift of monetary policy gears will
inevitably cause an interim correction in both markets.
o From 2004, the Japanese market has been outperforming its
global peers in all standardized global sectors except telecom
services and utilities. Indeed, the Japanese financial,
energy, consumer staples, industrials and information
technology sectors have massively outperformed their peers.
While we are not too enthusiastic about consumer discretionary
stocks at this point, we are intrigued by what's happening at
Mitsubishi Motors (code:7211) and suspect the company now has
room to surprise the street on the upside.
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@@ VIEWPOINT: The Fed Fixates on Jobs while the BOJ Focuses on Prices
The US economy pulled a hat trick on Friday, producing the fastest
pace in payrolls in nearly four years for March. It was possibly the
best economic news since the onset of the last recession in 2001, and
a sign of spring for the nation's labor market, which has been mired
in its longest slump since 1939.
Payrolls outside the farm sector grew by 308,000 jobs, compared with a
revised gain of 46,000 in February. But this was not the only source
of good news on job growth. The Institute of Supply Management
purchasing managers' employment index rose to 57 in March -- the
highest since December 1987 -- from 56.3 the prior month. A reading
above 50 indicates an increase in jobs, and the higher the reading,
the faster the pace of expansion. The implications of the surprisingly
good jobs number are:
1. It should ease some of the political pressure on president Bush,
thereby reducing some uncertainty about the November presidential
2. If there is more follow-through on the strong job growth numbers,
the game then becomes trying to figure out how much job growth will be
needed before the Fed is confident enough to begin tightening monetary
3. US bond prices won't wait until the Fed moves or for more
confirmation, but will react real time to further employment gains,
pushing up Treasury prices before the Fed moves to act. The reaction
to job growth could be greater given the absence of intervention to
support the dollar by the BOJ and the resulting purchases of US
treasuries by Asian central banks.
4. US consumers have been skeptical about job growth, and may be slow
to react to continued improvement. However, recovering job growth will
eventually boost consumer confidence (consumer spending accounts for
over 60 percent of the US economy).
5. This may also be the turning point for the US dollar versus the
euro and gold prices. The dollar had its biggest gain in a month
versus the euro after the jobs news hit the tape. More rounds of
dollar buying could come given more follow-through on job growth.
6. Oil also broke decisively below key support at $35 at the end of
New York trading. This level marked both previous support and
resistance, the 50 day moving average, rising trendline support from
last September and the neckline of a possible head and shoulders
pattern. Record high gasoline prices and extreme bullish sentiment
also may mark a high in oil prices. The breakdown in oil could drag
the CRB lower, which recently tested 284, the highest level since
Job growth acceleration means a stronger US economy, higher interest
rates and a recovery in the dollar. Like bonds, commodity prices will
not be waiting for confirmation by the Fed. Gold usually leads
commodity price movements and has been moving closely with euro/dollar
exchange rates. In addition, gold is more strongly affected than other
metals by hedge books. When interest rates begin to rise, gold
producers increase hedges and sell gold forward. Speculators also tend
to close their margin positions when rates rise, which means that gold
prices are negatively affected by rising interest rates. Consequently,
any significant breakdown in commodity prices could be the first sign
that the dollar has bottomed.
Over the past couple of years, governments and the markets have been
more concerned about the possible emergence of inflation. The Fed,
having carefully studied the Japanese malaise, was not shy about
aggressively lowering interest rates, while the new Republican White
House chimed in with tax breaks and fiscal stimulus. These reflation
efforts produced substantial rallies in just about every financial
asset except the dollar. Indeed, the dollar appears to have been the
only casualty of the exercise, despite ominous warnings of what could
happen if the dollar were allowed to continue depreciating.
But since foreign governments -- particularly in Asia -- "cooperated"
with the US in heavily intervening to prevent their currencies from
appreciating against the dollar, and in the process also helped to
keep rates in the US bond market with their purchases of US
treasuries, there was no "worst case scenario" for the US -- at least
not yet, and probably not as long as the US economy continues to
recover. These reflation efforts created a massive rally in commodity
markets, with the CRB futures index staging the best rally in 20
years, and commodities like copper, soy bean oil and platinum soaring
by 90 percent or more over the past two years. Bond prices benefited
as well, with the 10-Year US treasuries appreciating over 20 percent
during the same period. The rally in equities took a little longer,
with all this stimulus not igniting a rally in equities until the
second quarter of 2003.
As we have pointed out repeatedly, the transition from excess stimulus
to kick-start the economy to a more "normal" monetary policy that has
an eye on inflation will inevitably involve an interim correction.
While the latest correction in the US market may have been a prelude
to this correction, we do not believe it was *the* interim correction,
because neither the Fed nor the BOJ have moved yet. There simply was
not sufficient evidence that the economic recovery was robust enough
to withstand the stimulus withdrawal. The surprisingly good US jobs
number is nevertheless good news for Japan because it means that
Japan's developing indigenous economic recovery is not at risk of
being sideswiped by serious problems with the US economy.
The BOJ's March tankan also brought better-than-expected economic news
about the state of Japan's economic recovery. In the March survey,
there was further evidence that the recovery is deepening. The
diffusion index for large companies in the non-manufacturing sector
posted the highest figure since May 1992, and business confidence
among smaller firms has also improved.
Yet some important people in Japan, notably Shin Nakahara, a member of
the BOJ's policy board, still apparently believe that Japan's recovery
is a transient phenomenon. Nakahara is also bearish on the second half
outlook for the US economy (a popular sentiment in Japan these days),
according to an article recently published in the Nikkei.
However, when general opinion was much more dour on Japan, Nakahara
was a cheerleader for the Japanese economy. At a speech at the Spanish
Embassy in February, 2002, he had the following to say: "Recently,
reports on Japan's economy have carried headlines such as 'Terminally
Ill,' 'No Hope,' or even, 'Bankrupt Japan.' The tone of these
articles, like their shocking headlines, is frankly astonishingly
pessimistic. However, I have every faith in the Japanese economy's
strong potential because it remains a huge net external creditor, it
has a large current-account surplus, a high savings rate and vast
accumulated household wealth. My own view of Japan's economy can be
summarized as follows: It may harbor some substantial problems;
however, it is fully capable of reviving itself as long as all
economic players cooperate and direct their full energies at solving
these problems." Now that there is increasing evidence that Japan's
economy is indeed reviving itself, why the bearishness?
These comments may be aimed at pouring some cold water on all the
recent bullishness that has led to some speculation that the BOJ is
thinking about lifting the zero-interest-rate policy. Some overseas
investors are suggesting that it may be the BOJ, not the Fed, that
moves first to shift gears on interest rates. Favorable export reports
recently led to rumors in Japanese financial markets that the BOJ was
ready to move. BOJ governor Toshiko Fukui, appearing before a
parliamentary committee, felt obliged to make it clear that this is
not the case. He said he'll see sustained price inflation before
This notwithstanding, the end of Japan's massive intervention in
currency markets has apparently been brought about by: a) unusual
comments by Alan Greenspan about these interventions, and b) BOJ
governor Fukui. An article in The Times of London newspaper claimed
Japan's dollar-buying forex intervention had officially ended and
cited BOJ sources. The newspaper said the intervention campaign is
thought by Japanese officials to be no longer necessary because the
country's economic recovery is gathering strength. The BOJ sources are
reported to have told the paper that they would intervene in the
market only when there was extraordinary volatility, but made clear
that the unprecedented dollar purchases of the past seven months were
formally over. According to the Times, the end of intervention has
apparently been brought about by Fukui.
But this does not mean that the BOJ is on the verge of ending its
zero-interest-rate policy. "The Bank of Japan won't end its current
ultra-easy monetary policy until the economy is ready, although it
hopes to overcome deflation soon so that it can end the current
'abnormal' policy," Fukui said at a lower house financial committee.
"We want to succeed in fighting deflation so that we can graduate from
this abnormal policy and return to normal (policies) of interest rate
But Fukui added that while the central bank would like to "graduate"
from the current policy soon, it wouldn't do so until underlying
economic conditions were met. While noting that the economy has
recently been "moving in the right direction," Fukui said that further
efforts were needed to make the recovery more certain. "There will be
no exit (from quantitative easing) before the economy is ready,"
By "ready," he apparently means that the BOJ's benchmark for the "all
clear" signal is prices -- more specifically, the CPI. Fukui said the
central bank would not change its monetary policy until the core
consumer price index, which excludes volatile fresh food prices, shows
at least low inflation for a sustained period and is unlikely to fall
So while the Fed is keying on sustainable job growth as the evidence
that the US economic recovery is sustainable and is the trigger for
their shift in monetary policy gears, the BOJ is keying on the CPI and
the emergence of inflationary expectations as the trigger for their
abandonment of the zero-interest-rate policy. The impending shift of
monetary policy gears for both does not appear imminent. We believe
that both the US and Japanese equity markets have a grace period as
the US economy plays catch up in terms of producing job growth, while
budding inflationary expectations in the Japanese economy are given
time to diffuse further and completely eradicate lingering deflation.
This is short-term good news for both the US and Japanese equity
markets. The recent US job report helped the US market avoid a nastier
correction, as Nasdaq and particularly the technology sector were on
the verge of breaking down through their 200-day moving average. The
Amex Technology SPDR, reflecting general weakness in the tech sector,
peaked early in 2004 and had been correcting for the past two months.
An extended correction here threatened the health of the entire US
equity market. Last year, the US tech sector (as measured by the
Technology SPDR) had a great rally, tacking on 67 percent before
peaking early in 2004. But investors began to suspect that the tech
stocks could not deliver on promised earnings that were being
discounted in stock prices, not while the US economy was failing to
produce any job growth. The bounce off of the 200-day moving average
is assurance that the tech sector will continue to recover from the
aftermath of the post-2000 bubble.
Japan Outperforms in Nearly All Sectors
Year to date, the Japanese equity market has substantially
outperformed its global peers in all standardized global sectors
except telecom services and utilities. The Japanese financial, energy,
consumer staples, industrials and information technology sectors have
massively outperformed their peers. While a recovery in the US market
could incrementally draw some of the substantial foreign buying back
into US equities, there are still serious concerns about the dollar
and the US twin deficits. Meanwhile, economic growth in the euro zone
continues to sputter. That means that Japan should continue to be the
default choice for foreign investors through the next quarter, while
domestic institutions could very well experience a change in their
overly bearish view of the sustainability of the US economy in the
second half of fiscal 2004, and more importantly, of the Japanese
economy in the second half of the year. As we have pointed out
previously, we believe the domestic institutions will be the ones that
propel the Topix and/or the Nikkei to new highs over the next six
The Yomiuri newspaper first broke the story that Mitsubishi Motors
(code: 7211) had been keeping two sets of customer-complaint records
since as far back as 1969. The cover-up was exposed by a whistle-
blower who prompted a Transport Ministry inspection of Mitsubishi,
which found documents on faulty vehicles stashed away in employees'
lockers at Mitsubishi's head office. In other words, company officials
intentionally falsified quality reports to the Transport Ministry, all
the while knowing that the government would be led to believe that
everything was kosher.
The company's duplicity has cost it much. When the news broke in 2000,
Mitsubishi had to recall more than 800,000 vehicles in Japan and more
than a million worldwide. The company's stock price plummeted, and
Japan's normally toothless Transport Ministry had to take a bold
stance on the Mitsubishi issue given the public outcry. The agency
threatened to remove its safety approval ratings on all Mitsubishi
vehicles and also discussed the possibility of shutting down the
company for the remainder of the year. President Katsuhiko Kawasoe
resigned in disgrace. Japanese police raided Mitsubishi headquarters
in 2000. Repairs, costs and associated fees from the recalls topped
$70 million. The company has also had a long-running dispute with
women's groups in the US about sexual discrimination.
Under a deal announced in March 2000, DaimlerChrysler took effective
control of Mitsubishi. But DaimlerChrysler chairman Juergen Schrempp
insisted that his group would not take on Mitsubishi's vast interest-
bearing debt, standing at nearly 1.5 trillion yen at the time.
Subsequently, the turnaround of Mitsubishi by DaimlerChrysler has
proven difficult, even though the CEO since 2002 has been Schrempp's
appointee, Rolf Eckrodt. Unlike the Chrysler Group, which is entirely
controlled by DaimlerChrysler, Mitsubishi Motors has other big
shareholders. They include Mitsubishi Heavy Industries, the Bank of
Tokyo-Mitsubishi and Mitsubishi. These other shareholders are a proud
lot and not always singing from the same song sheet as
DaimlerChrysler. Mitsubishi Motors has struggled to overcome the
longtime cover-up of defects in Japan, sagging quality and too few
knock-out models. Last year, its recovery unraveled after a lax credit
policy in the US market, aimed at pumping up sales, led to high loan
defaults. As Mitsubishi Motors tightened its US credit policies, its
sales plummeted and its market share shrunk, to 1.5 percent this year
from 2.1 percent a year ago.
Last month, Mitsubishi Motors stunned investors by forecasting a $673
million loss for the fiscal year ending March 31. Just three months
earlier, it had predicted it would lose $99 million for the year.
Schrempp dispatched a team of executives led by Andreas Renschler, the
well-regarded chief of Mercedes-Benz's Smart minicar division, to
Japan to assess the problems. Renschler came up with a business plan
to be presented to DaimlerChrysler's top officials, including its
supervisory board members. Based on the business plan, DaimlerChrysler
and the Mitsubishi group agreed to appoint Renschler as president and
chief executive officer of Mitsubishi Motors in June as part of an
effort to rehabilitate the troubled company under more direct
The major shareholders have also agreed to consolidate the carmaker's
production bases in Japan and abroad and file for the application of
the industrial revitalization law with the Ministry of Economy, Trade
and Industry to make it easier to reduce heavy debts and eliminate
surplus facilities. Following the agreement, Eckrodt will resign at
the general shareholders meeting in late June to take responsibility
for the automaker's poor performance. The reduction of production
capacity in Japan and overseas constitutes the main pillar of the
rehabilitation plan, and DaimlerChrysler and the Mitsubishi group are
considering closing the factory of wholly owned Mitsubishi Motors
subsidiary Pajero Manufacturing, while maintaining two other domestic
factories in Aichi and Okayama prefectures.
Outside Japan, the automaker's Australian factory is to be closed and
sold off. Much of its output has been exported to North America, where
Mitsubishi Motors has been particularly struggling. In addition, a
large-scale production cut is planned at the factory in the state of
Illinois. In contrast, Mitsubishi Motors will likely expand joint
venture operations in China and strengthen production and sales in
Thailand and other Southeast Asian countries.
To finance the restructuring plans, the Mitsubishi group was initially
considering a capital increase of about 300 billion yen. But under
consideration now is whether to expand the financing to 400-500
billion yen to implement thorough revitalization measures. In
addition, Mitsubishi Motors may ask its creditor banks to infuse
capital through lending and share acquisitions. Overseas media are
reporting that DaimlerChrysler has already agreed to inject $400
million by increasing its stake in Mitsubishi Fuso Truck and Bus Corp.
But Schrempp is apparently against further investment in the
DaimlerChrysler reportedly estimated the share of the injection would
come to $900 million unless major shareholders agree on a recovery
plan. The threat was that DaimlerChrysler could cut its 37 percent
stake in Mitsubishi Motors if the other shareholders do not come
around by April 30, when Mitsubishi Motors hosts its annual
The interesting sidebar is that in the late 1990s, when France's
Renault was looking for a Japanese partner, its executives looked over
Mitsubishi Motors. But Renault chairman Louis Schweitzer said the
company opted for Nissan Motor because it was discouraged by a
pervading sense in the Mitsubishi group that drastic action was not
needed. One key to revitalizing Mitsubishi will be whether this sense
of crisis can be instilled.
The lack of crisis at Mitsubishi has resulted in a stock price 33
percent of what it was in 1999, while Nissan, which did have a sense
of crisis, has a stock price threefold that of 1999. Toyota and
Honda's stock prices have been basically flat since 1999. Both have
been the subject of a large amount of cross-holding unwinding.
Turning Point for Mitsubishi Motors?
The extraordinary shareholders meeting in late April is crucial for
Mitsubishi Motor's future, and the size of financial assistance is
surfacing as a major sticking point. Renschler reportedly indicated
that more than 500 billion yen may be needed to complete a
restructuring program that covers issues from labor cuts and closures
of production bases to the development of new cars and expansions in
the Asian market. The figure prompted representatives of Mitsubishi
group companies to demand the resignations of the current Mitsubishi
Motors management for putting the automaker in such dire straits.
Mitsubishi Motors and DaimlerChrysler hope to win a financial aid
package that includes debt forgiveness, but Bank of Tokyo-Mitsubishi
and other financial institutions that have already provided large
loans to Mitsubishi Motors and its group firms are reluctant to cough
up such huge amounts. Unlike Nissan Motor (7201), Mitsubishi Motors
lacks assets that it can sell to generate funds for its business
rehabilitation. The firm's shareholder-equity ratio was less than 8
percent at the end of September 2003, at 180 billion yen against some
1.1 trillion yen in liabilities. Mitsubishi Motor's poor credit rating
of BB, or speculative status, effectively rules out the option of
raising money through bond issuances.
For the time being, the new Mitsubishi Motors management will have a
lot to do, most of it involving efforts to clean up the company's
balance sheet and to restore a very tarnished brand name. The first
task will be to get the banks to sign off on the funding plans. Then
there is Mitsubishi Fuso, a newly spun off subsidiary of Mitsubishi
Motors, which said it will recall about 112,000 large vehicles due to
defective wheel hubs that caused a series of accidents, including a
fatal one in 2002. The company estimates that the recall will cost it
around 3 billion yen. However, the firm may end up spending more
because some models that are not compatible with the latest hub design
will be fitted with a temporary replacement and recalled later for a
permanent solution. Mitsubishi Fuso's sales this year were forecast to
fall nearly 20 percent in reaction to last year's strong sales, which
were hoisted by stricter diesel emission standards. Now, some analysts
are predicting a sharper sales decline this year because many trucking
companies are likely to refrain from buying Mitsubishi brand vehicles.
The recall is also likely to hurt Mitsubishi Motors' recovery. The
company's domestic sales last year grew 3.4 percent to about 367,000
vehicles. Although this marked its first increase in eight years, the
figure may fall again this year because domestic sales dropped more
than 10 percent after the 2000 scandal.
The street is skeptical given Mitsubishi Motor's recent history and
the lack of a sense of crisis that was sensed by Renault management
when it looked at the company. However, we do not believe that either
DaimlerChrysler or the Mitsubishi Group are willing to allow
Mitsubishi Motor to go under. DaimlerChrysler and major shareholders
at the Mitsubishi Group are beginning to sing off the same song sheet,
replacing top management with new management and gaining commitments
of the company and then put it back on the right track in terms of
product development and business strategy. Mitsubishi Motor's stock
price has woefully underperformed its peers, but has visited 210 yen
support over the past two years. While the clean-up will take a few
years, we believe that the company's stock price has already
discounted the bad news and loss of credibility with the investment
community. Consequently, any incremental improvements that can be made
over the next two years will be directly reflected in upside potential
for the stock price.
-- Darrel Whitten
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