Offshore Investment Theories

The long-heralded recovery in the Japanese financial markets appears as far away as ever. Michael Wilson looks at why government reforms have been slow to spark a revival

Will the Tokyo revival ever happen? A year ago you’d probably have dismissed this as one of those stupid questions, like “Will the euro ever strengthen?” or “Will the rain ever stop?” Of course it will, you’d have said. Simple logic tells us that you can’t undervalue a perfectly satisfactory manufacturing economy indefinitely. Sooner or later, the combined effects of a weaker currency and a stronger export position are bound to have the desired effect, and simple arbitrage pressures will force the Japanese stock market back into a proper state of balance with the international investment community. Shares are bound to go up.

Offshore Investment Theories - Signs

It’s a nice theory, but this year the signs are that things are working out differently. Japan’s official growth rate has just been regraded by foreign investment analysts from 1 per cent to as much as 2.2 per cent. Industrial production levels have been rising by as much as 10 per cent year-on-year and its newly-appointed government (somewhat hastily convened and re-elected in July, after the sudden hospitalisation of the serving Prime Minister) has made a passable job of a political transition that most people thought was beyond it. The yen has tumbled back by 7 per cent in the last year, making it easier for Japanese exporters to sell into foreign markets such as China or the US.
But the stock markets have been inconsolable: the Nikkei 225, Japan’s most important large-company index, has slumped by nearly a quarter since the late spring, and even the broader-based Topix is 12 per cent down on the year (all figures correct in mid-October).

Offshore Investment Theories - Japanese Private Investors

Even worse, it seems clear at present that Japanese private investors are in no mood for taking any further risks at all. They’re buying bonds, they’re opening bank accounts, they’re doing everything except investing in domestic Japanese equities. And all our recent conversations with fund managers and analysts have confirmed that, apart from a handful of small-company stock-pickers, nobody in the international markets has much of an appetite for Tokyo either.
Besides, some people are saying, we haven’t defined what we mean by a revival anyway. Do we mean a stock market revival that will carry company valuations to the kinds of levels that we might expect to see on Wall Street? If so, we’ve already arrived: average Japanese price/earnings ratios are almost twice what they are in the States - 60, and rising. How much higher would it be sensible for us to go?

Or do we mean an economic revival, perhaps? Japan has the world’s third-highest per capita income (after Switzerland and the US) and its industrial performance has improved quite a lot since the redundancy programmes of the past five years. Its current industrial expansion into other parts of South-East Asia (surely the world’s biggest potential developing country market) is both timely and well-judged, for reasons we’ll examine shortly. But foreign investment analysts are still muttering darkly that it will all end in tears.

Offshore Investment Theories & Moodys

Moodys, the world’s most widely-recognised credit rating agency, has recently downgraded Japan’s domestic bond rating by two full grades, leaving Japan on the same risk rating as Portugal. Increasingly, there are fears that Japan may have got itself so heavily mired in debt that its economic growth will never become fast enough to shrug it off.
Some of the most worrying trends are social. We know, of course, that Japan’s population profile is ageing faster than any other developed country in the world, because of low birth rates and much longer life spans during the past 40 years. Everyone is agreed that the question of pension provision will soon start to get very urgent and that Japanese companies will need to come up with something pretty special if they’re to pay for all these people with the money produced by a dwindling working-age population.

There are a lot of doubts out there in the marketplace about just how much it’s going to cost, and that’s part of the reason why so many fund managers are wary.

Offshore Investment Theories & Unemployment

The other main social factor is unemployment, something that we’ve already touched on. Now that unemployment levels are pushing 5 per cent, the highest rates in post-war history, people are scurrying down to their post offices and buying special government bonds with which to build up their retirement nest-eggs, rather than hitting the high streets with their credit cards. So the domestic consumer market is in crisis, shops are empty and even long-established chain stores are reporting losses.
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