After long rest, Japan is rising again
Buoyant equity markets could draw support from trillions held in postal accounts, writes Chris Oliver
Fund managers are increasingly confident the pickup in Japan's economy is part of genuine economic revival and not another blip in the country's decade-long bout with recession and deflation.
The view was bolstered last week by news that Tokyo land prices recorded their first increases, measured on a six-month basis, since the collapse of the bubble economy in 1989. Higher property prices point to a return of inflation, fund managers say. This could be a catalyst to trigger US$2.9 trillion out of low-yielding postal savings and deposit insurance and drive an equity bonanza.
Helping to divert those funds into stock and bond markets, three fund houses will begin distributing products directly through 1,330 post offices in the coming year, as part of reform packages recently introduced by the Koizumi administration. Banks have also recently started selling equity funds, broadening access to the investment products which were previously only available through brokerages.
Koichi Ikegami, spokesman for Nomura Securities, one of the groups authorised to distribute investment products through the post office, believes it signals an important turning point for risk-adverse Japanese investors. Long accustomed to parking cash in near-zero interest bearing accounts, access to the new investment products should encourage asset diversification.
Expected to be popular are foreign currency bonds which yield well above Japanese sovereigns, but investors are also searching beyond fixed income. 'As Japan's society ages, we look for semi-enforced savings for home acquisitions to shrink, stimulating new demand for risk assets,' says Mr Ikegami, adding that rising dividend payouts are an attractive source of income for babyboomers about to retire. Nomura equity funds are attracting roughly 1 billion yen in new funds every month.
Japanese companies are paying out more earnings as dividends, and are quickly approaching a threshold where they will exceed bond market yields.
'If the dividend ratio improves by 10 percentage points, the average corporate dividend yield will be closer to 2 per cent,' says Merrill Lynch fund manager Naoya Orime. 'The current Japanese bond yield is a lot lower, so this will attract a lot of individual investors.'
Foreign fund managers are also warming to the corporate restructuring story, according to the London-based head of equity research at Barclays Investment Services, Gary Dugan.
'Japan is one market that we think can double over the next five years,' he said. 'We've seen a change that hasn't been seen in the last 10 to 15 years. The Nikkei will go a lot higher. Fundamentally, this market is seriously undervalued.'
He says the Japanese economy has worked off most of the excesses of its bubble days. The 1990s bust left the economy saddled with three major problems: high debt levels, an inefficient and bloated labour market, and excessive industrial capacity. Many of these problems have been worked out, albeit slowly over the past decade. Debt levels have been slashed, excess production capacity eliminated and payrolls trimmed.
Mr Dugan says news last week of Sony's laying off of 10,000 workers showed just how far the new thinking has permeated the corporate hierarchy. Chief executives are well aware that stocks with high return on equity have led the 225-issue Nikkei Stock Average above 13,000 for the first time in four years. 'The private sector is delivering,' Mr Dugan says.
Recent data show Japan's GDP grew at an annualised pace of 3.3 per cent in the April-June quarter for the third straight quarter of growth. According to Barclay's estimates, GDP should expand 1.8 per cent next year.
Earnings are forecast to rise 23.2 per cent this year, and 13.9 per cent the following year, against a world index of 13.7 per cent and 10.3 per cent respectively, according to Morgan Stanley Capital Index estimates. If 2006 lives up to expectations, it will be the fifth consecutive year of higher earnings.
Rising spending and corporate profits are also helping make Japan's economic recovery sustainable, Japan's Finance Minister Sadakazu Tanigaki said last week.
The soft patch earlier this year, which showed the Japanese economy had slipped back into recession, had more to do with a cyclical build up in the inventory cycle, rather than a slowdown in economic activity said Mr Ikegami.
'We no longer see any reason to question the current strength in the domestic economy,' he says. 'Our focus has therefore moved to the sustainability of the recovery. We note recent signs the Japanese economy is reducing its dependence on exports and is being underpinned to a greater extent by capital expenditure.'
High oil prices are not likely to have as deep an effect on the Japanese economy, many analysts believe, because it takes about half the amount of energy to produce one unit of GDP when compared to other developed markets.
Jeroen Touw, fund manager with ABN Amro's Japan Equity Fund, expects limited impact on either industrial production or consumer spending.
'Japan does not suffer from the same imbalances as the United States as consumers are not indebted and the housing bubble has already been deflated,' he says. 'As the Japanese consumer is still far less impacted by higher oil prices, spending will be less impacted as well.'
In addition to rising corporate profits, he says companies are more shareholder friendly these days and are handling cash back to investors. He adds the ongoing restructuring may lead to a rerating of the market. Banks are in better shape while the ruling party has been cleansed of the old guard who hampered reform. 'The post office, although important in itself, is only a symptom of political reform and we anticipate additional reform initiatives in areas such as healthcare and pensions.'
There are some reasons for caution, however. Japan's government debt mushroomed to a record high of 795.8 trillion yen at the end of June, according to a report released by the Finance Ministry last week. The amount is equivalent to about 6.24 million yen for every Japanese, or almost 160 per cent of GDP and already the highest in the industrialized world.
A falling birth rate and ageing population also means that by 2025 those aged over 80 will outnumber any other group. The system will put an enormous strain on government finances, but might not spell doom for the equity markets.
Mr Ikegami believes the corporate sector will still benefit by exporting capital for foreign investment and reinvesting the profits overseas.
Despite Japan's energy efficiency, high oil prices are beginning to impact on exports, with figures for August showing the trade surplus fell 80 per cent from a year ago.