J@pan Inc Magazine Presents:
M O N E Y W A T C H
Weekly Financial Commentary from Tokyo
Issue No. 73
Tuesday, April 20, 2004
@@ VIEWPOINT: Caution! Everyone is Bullish on Japan These Days
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@@ VIEWPOINT: Caution! Everyone is Bullish on Japan These Days
The Bottom Line:
o Investor surveys show that global investors are more bullish
on Japan than ever, even as they fret about inflation, a
Federal Reserve move toward a monetary tightening bias and a
growth slowdown in overheating China. Has foreign bullishness
on Japan now gone too far?
o We don't think so, at least not yet. US interest rates (and,
indeed, global interest rates) have only one direction to go,
and that is up, especially now that the Asian nations and
Japan in particular are no longer keeping a lid on US bond
prices through massive purchases of US treasuries that were
related to equally massive intervention to prevent their
currencies from appreciating against the dollar. But the
positive correlation between US bond yields and the Nikkei
index would indicate that rising interest rates in the US mean
a strong economy and a recovering dollar, which is positive
for Japanese equities.
o Moreover, slowing China growth, if it can be accomplished
without slamming on the brakes of imports as China has been
known to do, will be basically a mid-cycle pause and not the
beginning of a global recession, as some people suggest. In
addition, as we mentioned last week, China is certainly the
most noticeable but not the only rapidly growing economy in
the world. China, along with Brazil, Russia, India and others
will continue to expand their relative importance in the
o But perhaps more important is the conjecture that Japan's
domestic recovery is not a fluke and not only driven by
external demand. Japan is in the best position in the last 10
years to shed the pall of the Heisei Malaise that has
strangled her domestic economy. Nowhere is this more
noticeable than in the stock prices of Japan's major banks and
its "basket cases" once given up for bankruptcy, like Daiei,
Seiyu and Mitsubishi Motors. Finally, there is Japan's small
caps, as represented by the Jasdaq.
o Economics isn't called the "dismal science" for nothing. Just
as markets were beginning to discount upbeat economic news and
even the IMF was talking about a "sweet spot," economists
began to fret about China and how a slowdown there could
derail the Japanese recovery and recoveries in other Asian
nations. But if one subscribes to a hard-landing scenario for
China, one has to be bearish on all global equities. Moreover,
the implication of "mega-trend" analysis by Goldman Sachs,
Standard Life and others indicates that the global economy
will be much different by 2050, with the BRICs (Brazil,
Russia, India, China) in the ascendancy as the traditional
OECD nations are overtaken to the point that the G-6 (the US,
UK, Japan, Germany, France and Italy) in 2050 could well be
composed of a very different group of nations. Rather than
despair for Japan, one needs to take a hard look at Euroland
if these mega-trends have any credibility. In short, the euro
is significantly overvalued versus these mega-trend
o However, it is unrealistic to expect such gains can be
repeated indefinitely. In fiscal 2003, the Topix was up 49.6
percent for the fiscal year, led by a 116.8-percent surge in
the real estate section, a 110.4-percent gain in the bank
sector, a 107.3-percent gain in the insurance sector, a
105.0-percent gain in nonbank financials, a 95.5-percent gain
in iron/steel, and a 92.5-percent gain in securities brokers.
Moreover, the second section of the Tokyo Stock Exchange was
up 83.9 percent, and Jasdaq surged 109.5 percent.
o While the US will likely have to move first to tighten
monetary policy, Japan will eventually have to move as well,
abandoning its zero-interest-rate policy and allowing interest
rates to move back toward more "normal" levels. This is likely
to crimp the soaring prices of the junk stocks that were
leading Japan's stock market in 2003. From December, previous
high-flying, liquidity-driven sectors such as shipping,
nonferrous metals and mining are up only 5.6 percent, 8.0
percent and 5.4 percent, respectively, and could see a
sell-off if their global peers fall out of bed. High-tech
precisions are even worse, gaining only 2.6 percent during the
period on fears that a peaking of the semiconductor cycle may
already be in sight. Thus while we remain bullish on Japan, we
are also taking a closer look at earnings quality for
individual stock selection and certainly not chasing prices.
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@@ VIEWPOINT: Caution! Everyone is Bullish on Japan These Days
As we pointed out in Money Watch No. 69, central banks, particularly
the US Federal Reserve, have laid the groundwork for significant
inflation once the economic recovery takes hold. One only need look to
the significant rises in all manner of commodity prices to see that
reflation is taking hold and will eventually work its way into
consumer prices. And once inflation takes hold, it just can't be
turned off overnight. This implies an extended period of rising
interest rates that the US market is already trying to discount. The
US market is now between a rock and a hard place. If US job growth
were to actually accelerate to the levels ostensibly needed by the
Bush campaign to ensure President Bush's re-election in November, the
Fed would quickly change its tune about being "patient" on interest
rates and its monetary policy stance, particularly because the bond
market would lead the way by discounting the next stage of price rises
as they pass along to the next level of the supply chain. Indeed, the
blow-out jobs number for March sent shock waves through the US bond
market that are still being felt. Investors fear that the Fed will
move to a tightening mode at the next Federal Open Market Committee
(FOMC) meeting on May 4. Moreover, this will be only the first volley
in the coming war on inflation.
But this scenario of the Fed being ready to move on rates is
incongruent with another scenario where the global economic recovery
nears its peak. This scenario has investors fearing that a significant
slowing of China's rapid domestic expansion and voracious appetite for
basic materials will spoil the party in basic materials and the
shipping markets and possibly derail not only Japan's economic
recovery, but the OECD's as well. China's government has promised to
clamp down and is moving to tighten monetary policy. But outsiders are
skeptical about Premier Wen Jiabao's goal of lowering GDP from 9.1
percent to 7 percent this year. Can it be achieved without a bursting
of the China bubble? Many believe that provincial and city officials
around China will ignore Beijing's efforts to deflate the growing
China bubble. Investors and the Chinese government are afraid that
excessive growth will lead to inflation, shortages of commodities and
electricity, and perhaps a bursting of the bubble when government
efforts to slow growth do kick in. If this is true, then industrial
metals like copper are a sell because shipping companies have seen
their shipping rates skyrocket on China demand.
Shipping Rates: Is China the Only Story?
Global shipping companies are seeing boom times, propelled by firm
dry-bulk freight rates and robust tanker earnings. Recent data from
Clarksons Research Studies shows that spot earnings per day have shot
up to $70,692 versus $30,727 a year ago for capesize vessels in the
dry-bulk category. Though this rate is marginally lower than $71,700
prevailing a month ago, it still is 105 percent more than its
five-year peak. In addition, freight rates are double their five-year
highs for other vessels such as Panamax and Handymax.
The firmness in the dry-bulk freight rates, witnessed in the past six
months, is expected to persist by those in the shipping industry
unless the global economic recovery really sputters. Because of
shipping capacity, pricing and quality issues, average hauling
distances have become longer, implying that the factors which are
causing increased demand for ship tonnage will not dramatically
change. The lack of supply of vessels vis-・vis demand is being
attributed to under-investment in the dry-bulk sector. Moreover, as
Europe phases out its single hull vessels because of environment
concerns, its demand for double hull ships has only accentuated the
Industry insiders say up to 25 percent of the world's bulk shipping
capacity is now tied up in port queues. While new deliveries will take
time, most of the shipping yards are booked till the first half of
2006-07. With this shortage expected to persist, freight rates are
likely to remain firm, shipping companies believe. In the tanker
segment, spot earnings for April have increased to nearly $54,000 per
day versus $51,000 per day a year ago for very large crude carriers.
This represents an improvement of 18 percent over five-year highs.
But earnings from crude carriers (tankers) and those in the dry-bulk
category have slipped from their recent highs, while Baltic dry
freight rates for capesize carriers have plunged along with stock
prices of shipping companies around the world.
Japan's Shipping Companies Ready for a Tumble?
In 2003, stock prices of shipping companies such as Mitsui OSK (9104)
and Kawasaki Kisen (9107) more than doubled. So far, the bad news
about falling freight rates has hurt the stock prices of Japanese
shipping companies, given the extreme bullishness of global investors
regarding the Japanese market and the fact that Japanese management
are still giving upbeat messages to investors. Their Asian peers,
however, have been hit harder in March, after stock prices literally
exploded from the onset of 2004.
Actually, soaring shipping rates connect with US interest rate fears.
Freight rates are giving clear warnings about the impact of higher
rates on financial markets. A further decline in the indexes should
lead to lower commodity prices. Gold prices, which often lead other
commodity prices, first peaked in January 2004 and hit a double top in
April. This is because gold prices are more sensitive to US interest
rates than industrial commodities because of the strong investment
demand (futures positions) that have supported gold prices.
Additionally, the fear of rates is finally beginning to bite into the
real estate segment. The Dow Jones REIT index, after a late rally that
tacked on some 20 percent to April, has rapidly retraced all the gains
made since last November.
Liquidity-driven markets in 2003 created some strange bedfellows. Gold
and mining stocks were soaring, while the bombed-out tech, media and
telcom stocks rallied and the housing sector as well as REITs
continued to do well. Normally, soaring commodity prices and shipping
rates would have meant noticeable upward pressure on US interest
rates. What happened instead was that, while the Fed's all-out
reflation efforts to restart US growth hit the dollar, efforts by
Japan and other Asian countries to limit the appreciation of their
currencies led them to purchase massive amounts of US treasuries,
thereby keeping a lid on US rates.
But global investors are now beginning to suspect the party from the
global liquidity cycle is ending. The IMF said in a report last week
the abundance of funds globally and the low interest rates were big
threats to financial-sector stability. Indeed, the $1.5 billion the US
needs each day to fund its massive current account deficit is looking
more bubble-like and unsustainable, with the Fed perceived to be on
the verge of raising rates. Japan has now stopped its massive
interventions, effectively removing support for US bond prices.
Ironically, the dollar rally has probably been exerting as much
pressure on the bond market as fears of credit tightening by the Fed
would normally warrant. All of this is occurring as some investors
have been operating on the suspicion that the US rally in 2003 was an
excess liquidity-driven fluke and that the US market could continue to
produce sub-standard returns for many years to come.
Has Foreign Investor Bullishness on Japan Overshot Fundamentals?
The latest survey of global investors by Merrill Lynch shows Japan as
the market that most global investors want to overweight because of
perceived attractive valuations relative to other markets, a better
corporate profit outlook than its peers and an undervalued currency in
the yen. Yet most also believe that China's economy is more likely to
weaken over the next 12 months, and while they are still skeptical
about US growth, inflation concerns dominate. The positive correlation
between the Nikkei index and US treasuries would suggest that rising
interest rates in the US are actually positive for Japanese equities.
Has all this bullishness gone too far? Not if one subscribes to the
scenario that we do, which is that Japan's recovery is not a fluke and
is not only driven by external demand. Japan may not be poised to rule
the industrialized world (as was implied in "Trading Places" many
years ago), but she is now in the best position in perhaps the last 10
years to shed the pall of the Heisei Malaise. Moreover, compared to
euro economic fundamentals, Japan looks strong. Global investors in
particular are underweight markets like the UK in favor of Japan. The
shift to a tightening bias in the US, as we are already seeing, will
be positive for the Japanese market initially and probably means good
relative performance through June. However, the Bank of Japan will
eventually have to consider its own shift of monetary policy gears.
The Japanese market will then suffer an interim correction as the
froth of the liquidity cycle eventually gives way to sustainable
-- Darrel Whitten
Money Watch No. 69
THE ABW MARKET LETTER
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