MW-65 -- Revitalizing Japan: Not Rocket Science, but Execution

J@pan Inc Magazine Presents:
Weekly Financial Commentary from Tokyo

Issue No. 65
Tuesday, February 24, 2004

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++ Viewpoint: Revitalizing Japan: Not Rocket Science, but Execution

The Bottom Line:

o The US consumer price index rose sharply in January (up 0.5
percent following a rise of 0.2 percent in December) driven by
the largest jump in energy prices since March 2003, when the
Iraq war began. Besides the usual medium-term negative impact
on economic growth (higher oil prices act like a tax on
consumption), oil price rises have also been shown to have a
short-term impact on the stock market's level with a one-month
lag, especially if the monthly rise in oil prices is more than
5 percent.

o The S&P 500 has now recovered all the ground lost since
January 2002 and is starting to look top-heavy vis-・vis its
40-week moving average of 1,040.58. The biggest concern
vis-・vis the high US valuations is that these valuations have
much less tolerance for inflation and higher interest rates.
The US Federal Reserve is probably more aware than anyone else
that when it does start to move on interest rates, financial
markets will react swiftly and violently. Indeed, even the
hint of such action is cause for noticeable swings caused by

o On a global relative basis, investor surveys still indicate
that global and international fund managers consider Japanese
equities and the yen relatively undervalued. Moreover, the
bullish expectations for Japan's economic recovery were
apparently vindicated, as Japan's GDP for the fourth quarter
to December 2003 recorded blowout annualized year-on-year
growth of 7 percent, the fastest growth since the June 1990
quarter. It also marked the fourth consecutive quarter of
quarter-on-quarter expansion. Moreover, the Bank of Japan
seems to be much further away from any move to tighten
monetary policy than the Fed.

o The Japanese market is looking just as top-heavy as the US.
The market has already once tested downside resistance as the
Topix retraced 48 percent (or 164 points) of the 44.6-percent
move from lows in March 2003 to the rebound high in October
2003 and briefly touched its 200-day moving average in
November of last year. Thus it is Money Watch's suspicion that
internal seasonal factors and the current supply-demand
picture are more of a factor in the recent sideways trading of
the Japanese benchmark indexes than any significant change for
the worse in market fundamentals. Issuers have been lining up
since the fourth quarter of last year to take advantage of the
highest trading volumes since the bubble days and buoyant
stock prices. Shinsei Bank just tapped the markets for some
250 billion yen, while the government is lining up to sell off
a stake in JR West, would like to sell more of NTT and, if
there is any market appetite left, sell off a chunk of Japan
Tobacco as well.

o Once past the usual fiscal year-end positioning by domestic
financial institutions, the supply-demand picture should clear
noticeably during the April-June period, paving the way for
another try at October highs and perhaps even 12,000 on the
Nikkei index. Money Watch believes that foreign investors
should stick with quality stocks, which in all likelihood will
prove to be more "defensive" than some of the so-called
"defensives" currently being traded.

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++ Viewpoint: Revitalizing Japan: Not Rocket Science, but Execution

The US Labor Department said that the US consumer price index rose 0.5
percent in January following a rise of 0.2 percent in December, driven
by the largest jump in energy prices since March 2003, when the Iraq
war began. Crude prices have been toying with $35 per barrel since
late January, and US oil inventories are at the lowest levels since
late 2000 or early 2003. OPEC surprised oil traders last Tuesday by
deciding to cut its production quota by a million barrels to 23.5
million barrels a day starting April 1 and to immediately cut the
daily 1.5 million barrels that's being pumped above supply quotas.
Prices could moderate as the weather warms, but they are expected to
stay high.

Higher energy prices are commonly said to act as a tax on the economy
because money that consumers and businesses might otherwise spend on
consumer durables and staples goes into gas tanks and furnaces. Big
spikes in the price of oil -- like in 1973, 1979, 1990 and 2000 --
have often been contributing factors to recessions, and economists had
been counting on consumers enjoying the benefits of lower federal
income tax rates in the first half of the year, along with tax refund
checks that are expected to be larger on average than a year ago. But
a large portion of the tax refunds that are scheduled to arrive in
March and April could instead be dedicated to higher energy costs. Oil
price rises also have a short-term impact on the stock market's level.
Over the last 30 years, stock investors could have beaten a buy-and-
hold strategy by following a simple market-timing model based on the
price of oil.

That is the conclusion of a new study by Ben Jacobsen, an associate
professor of finance at Erasmus University in Rotterdam, and two of
his students. They examined the impact of oil prices on the US stock
market between October 1973 and April 2003 as well as the impact on
the stock markets of 17 other industrialized countries and of 30
emerging-market nations over shorter periods. They found that changes
in oil prices had considerable predictive power over short-term market
moves. In a number of countries, in fact, the researchers' oil-based
market-timing model was even more profitable than it was in the US. In
other words, the monthly performance of the stock market is
negatively affected by a more than 5-percent move in oil prices the
month before and vice-versa.

The S&P 500 has now recovered all the ground lost since January 2002
and is starting to look top-heavy vis-・vis its 40-week moving average
of 1,040.58. Surveys by Merrill Lynch and Reuters show that the US is
still the preferred underweight in global portfolios, but it has the
biggest overweight in technology even though the sector is seen as
expensive, at least in terms of the US market. By currency, the yen
and now the US dollar are looking undervalued vis-・vis the euro,
which most think is becoming overvalued. The biggest concern with the
high valuations in the US is that they ostensibly would have much less
resistance to inflation and the inevitably higher interest rates that
inflation brings. Yes, the US Federal Reserve continues to try and
push the interest-rate envelope as far as possible, but even it admits
that the US economy has surprised on the upside, while energy prices
are pushing up inflation and industrial commodity prices have soared.
The Fed is well aware that when it does start to move on interest
rates, financial markets will react swiftly and violently. Even the
hint of such action is cause for noticeable swings. Consequently, the
Fed may not move on rates for longer than the markets currently think.

Confidence in the quality of US earnings remains higher than it is for
European and Japanese earnings. Consequently, many investors appear to
be hedging their bets with higher exposure to consumer staples and
retail, while reducing exposure to "early cycle" basic materials. The
exception to this is energy. However, should interest-rate fears take
the upper hand and the dollar's recent rebound prove short-lived, the
S&P 500 could easily correct down to its 40-week moving average of
1,040.58. This would represent a modest correction of a little over 9
percent from current levels, or a retracing of 109 points on the S&P
500 (29 percent of the 370 point gain seen in the index since March
2003 lows).

The dollar soared by more than two yen late last week, completing its
biggest weekly rise in five months, ostensibly on a terror alert in
Japan that prompted the mobilization of armed police forces in over
500 facilities. But the US dollar has been trying to bottom out for
some time, with the euro topping out at $1.30 and 105 yen to the
dollar looking more defensible that a few weeks ago. The dollar index
could rebound as much as 9 percent from recent lows before bumping
into its 40-week moving average of 92.06.

While Money Watch pointed out this possibility several weeks ago, the
dollar did move to confirm support at 85.0, and has yet to
convincingly move past the recent rebound high just above 87.5. Yet
investors and traders are increasingly nervous about their long-yen,
short-dollar positioning. Net long yen positions on the Chicago
Mercantile Exchange were still close to 19-year highs during the week
of February 13, and a partial unwinding of this one-way positioning
would provide good short-term support for the dollar. However, given
that the US has yet to get its twin deficits under control, the
secular trend is still bearish. This rebound will be but a brief
respite until: a) the US begins to move on interest rates, or b)
the US balance of trade begins to turn.

On a global relative basis, investor surveys still indicate that
global and international fund managers consider Japanese equities and
the yen relatively undervalued. Conversely, the euro is looking
increasingly overvalued. With US equities still viewed as expensive in
valuation terms and the dollar still in a secular bear market, Japan
equities are relatively more attractive, albeit less so than in 2003.

The bullish expectations for Japan's economic recovery were vindicated
as Japan's GDP for the fourth quarter to December 2003 recorded
blowout annualized year-on-year growth of 7 percent, the fastest
growth since the June 1990 quarter. It also marked the fourth
consecutive quarter of quarter-on-quarter expansion. This has
strengthened the perception that at long last, this recovery may be
for real. Investors are now looking to the March tankan (the Bank of
Japan's quarterly business survey) for further confirmation and
perhaps a pleasant upside surprise. The December tankan gave a hint of
the fourth quarter GDP numbers with a surprising improvement in
business sentiment to the highest level in more than three years. Yet
the stock market's celebration of the most recent economic news was
brief, as the blowout number only reflected what the stock market was
trying to discount as early as the second quarter of 2003.

The Topix has already retraced 48 percent (or 164 points) of the
44.6-percent move from lows in March 2003 to the rebound high in
October 2003. It briefly touched its 200-day moving average in
November. It is Money Watch's suspicion that internal seasonal factors
and the current supply-demand picture are more of a factor in the
recent sideways trading of the Japanese benchmark indexes than any
significant change for the worse in market fundamentals.

Shinsei Bank (8303), the restructured and reformed Long-Term Credit
Bank of Japan, made its debut on the Tokyo Stock Exchange on February
19 with a closing price of 827 yen. It first traded at 872, up 66
percent from an initial offering price of 525, with trading value
reaching 210 billion yen, or 17 percent of trading value on the TSE.
In selling off 440 million shares of 1.358 billion shares held, the
Ripplewood Holdings consortium realized profits of some 100 billion
yen and has paper profits on its remaining holdings of Shinsei
amounting to around 680 billion yen. In addition, the Japanese
government still owns approximately one-third of Shinsei's outstanding

Following in Shinsei's footsteps, the Japanese government plans to
sell off its entire 31.72-percent stake in West Japan Railway Co.
(9021) in March. The government will offer 634,344 shares in the
company, more commonly known as JR West, through a global offering.
Forty-four brokerage houses will underwrite its shares in the
domestic market, while 11 securities firms will place the shares
with overseas investors. The offering price will be set between
March 5 and 10. Share subscriptions will take place during
three sessions. Based on Friday's closing price of 400,000 yen, the
offering of 634,344 shares would soak up 253.7 billion yen from
global equities markets, following the 250 billion yen procured by

The Ministry of Finance is also considering selling off its stake in
NTT only once in fiscal 2004 instead of twice -- in May or November.
The government holds 7.22 million NTT shares, giving it a 45.4-percent
stake in the telephone giant. Of these, 1.92 million shares will be
available for sale because the firm must be one-third owned by the
state. Another million shares are slated to be sold next fiscal year,
reducing the government's stake to 39.1 percent. The government has
been forced to refrain from selling NTT shares for the last few years
because of a falling stock price. But with tax revenues declining and
many government bonds maturing in the coming fiscal year, the
government is desperate to generate income and believes that selling
NTT shares in bulk is a good way to do so.

The Finance Ministry is also eyeing a sale of its Japan Tobacco stock.
Of the roughly 1.28 million shares it holds in JT, the government is
allowed to sell about 280,000. Selling on this scale would generate
more than 209 billion yen at current prices.

After a two-year slump, equity and equity-related issues in Japan
revived in 2003, posting a 78.6-percent increase for the year to
around 4 trillion yen, with a particular surge in underwriting
activity -- the largest increase since 1998 -- being seen in the
fourth quarter. Given the highest levels of daily trading value seen
since the bubble years and participation by active day-trading
individual investors, the equity market's capacity to absorb such
capital calls has improved markedly since early 2003, when daily
trading volumes were limping along at under 300 billion yen per day.

However, these new issues are a drag on Japan's stock market,
especially in periods of seasonal excess supply (such as now), when
domestic institutions are positioning their portfolios in preparation
to close accounts at the end of March 2004. Money Watch expects the
supply-demand picture to brighten somewhat from the onset of the new
fiscal year in April. We believe that the next challenge to October
2003 rebound highs will occur during the second quarter of 2004. Until
such time, however, even the MSCI Japan dollar-denominated ETF (EWJ)
is looking top-heavy and could correct to its 40-week moving average
of $8.50 (versus $9.51 presently).

Shinsei is a new breed -- along with Nissan -- of global hybrids that
apply the Japanese saying of *wakon yosai* (Western techniques,
Japanese spirit) management style. It is one that disregards
long-standing cross-shareholding arrangements, one that delegates
decision-making in large part to the lower ranks, one that actively
forges unconventional partnerships and one that features a solid,
Western-style corporate governance structure. Long-Term Credit Bank
was nationalized in 1998 and sold to a consortium led by Ripplewood
Holdings in 2000, meaning that the bank was revitalized in just five

The bank's ratio of nonperforming loans to overall loans was 4.1
percent at the end of September, below the average of 6.5 percent
among large Japanese banks. In addition, the bank's bad loans are
almost 100 percent covered by collateral and loan loss reserves.
Controversial deferred tax assets account for only 3 percent of
Shinsei's core capital, versus about 40 percent at the major banks.

Moreover, Shinsei has a noticeably different business model than
Japan's surviving megabanks. The bank focuses on generating profits
from businesses other than lending and places importance on investment
banking and bad-loan-related businesses. In fact, loan assets have
dwindled by nearly half to 3.6 trillion yen since it began operations
as Shinsei. Bank president Masamoto Yashiro contends that Japan has a
glut of banks working in the area of corporate financing, and Japanese
financial institutions are unable to charge interest rates
corresponding with the risk of borrower defaults. Shinsei is relying
more on fee income from securitization operations, arranging
financial-derivatives products and serving as an intermediary for
corporate acquisitions. For the fiscal first half through September
30, 2003, earnings other than that from interest income made up more
than half of Shinsei's total earnings. Its return on total assets
stood at 1 percent, surpassing the average 0.5-percent rate for its
major rivals and closing in on the roughly 1.3 percent of prominent
European and US banks.

Only a handful of Japanese companies ever lived up to the Japan Inc.
myth, and Nissan (7201) wasn't one of them. Almost bankrupt by 1999,
it was bought out by Renault with the purchase of a 44.3-percent
controlling stake. Nissan's sales in the US had shrunk by more than 30
percent from the mid-1980s, and costs of its *keiretsu* and lifetime-
employment traditions were all but strangling a company with no
revenue growth. But Nissan's engine technology is the best in the
business as are its manufacturing plants. The Sunderland plant's
productivity level of 98 cars per employee in l997 was among the
highest in the world. In 2002, Nissan set the automotive industry
benchmark as the most efficient manufacturer in North America for the
eighth straight year, according to the prestigious Harbour Report
North America 2002. Nissan also offered a window onto Asia's market,
which could prove to be a bonanza.

Carlos Ghosn wasted no time at Nissan. Before Ghosn, Nissan had made
money only one year in the previous eight, was $18 billion in debt and
had been losing market share in Japan for 26 consecutive years and
globally for eight. The Nissan Revival Plan combined initiatives to
build Nissan's business and market presence, and reduce costs by 1
trillion yen and net debt from 1.4 trillion yen to less than 700
billion yen by fiscal 2002. Three assembly plants in Japan were to be
closed as well as two powertrain operations. Worldwide headcount was
to be slashed by 21,000, and key functions were to be globalized.
Reducing purchasing costs was a key component of the plan's overall
success. Purchasing policy was centralized and executed globally.
Purchasing costs, which represented 60 percent of the company's
total costs, were to be reduced by 20 percent over three years
and the number of parts and materials suppliers slashed to 600
from 1,145 groups currently. A significant part of the overall savings
came from how Nissan worked with its suppliers. The significantly
increased economies of scales for parts and materials benefited
Nissan's "partnership suppliers" and delivered substantial savings for
the company.

It was a legendary turnaround. Nissan North America is now on the
verge of making history in 2004: It may see its US sales increase an
astounding 200,000 units from 2003. Since the 1999 equity swap with
Renault SA, Ghosn has not just slashed costs, he has diversified
Nissan's product portfolio and shored up some of its existing
products, most notably its Infiniti luxury brand. Its once-bland
Nissan marque now has many more stylish offerings such as the Murano
cross/utility vehicle and 350Z sports car -- and it's entering new
segments (large pickups and full-size SUVs) to boot. In 1999, Nissan
was in the midst of a 21-year low in market share (4.0 percent). This
year it's on track for 4.8 percent, the highest since 1997. Its best-
ever annual market share was 5.62 percent in 1980.

These two are the best examples of Japan's new foreign-owned hybrids,
but there are also purely domestic "hybrids" such as Canon (7751), JSR
(4185) and Nidec (6594), which have reinvented themselves and are
showing that revitalizing Japan is not rocket science or entirely
dependent on government policy, but more simply a matter of clear
vision, discipline and capable management.

-- Darrel Whitten

Entrepreneur Association of Tokyo - March Seminar

Ms. Ruriko Nomura is the President of Hopes Inc., a frontier company
aiming to establish an educational consulting field. Her presentation
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about the opportunities in the Japanese business world that she

Date: Tuesday, March 2nd Language: English Email:
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Written by Darrel Whitten

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