Biggest risk is being underweight in Japan

POLITICAL upheaval in Japan has failed to dent many fund managers' optimism that Japan could offer investors some of the best surprises of the year. Shigeki Makino, fund manager with Fidelity Investment Services Japan, told investment advisers yesterday that the biggest risk at the moment ''is being out of Japanese equities''. Mr Makino, speaking at an investment seminar, believed a massive round of corporate cost cutting, cheap valuations and lack of sentiment from overseas buyers all point to bargains being found for the adventurous investor. He said: ''At this point in the economic cycle, the risk is not that the economy gets significantly worse, but that it gets better. In other words, the risk is not being well weighted in Japan, it is being underweight.'' Investors in Japan did not have a good time in the 1990s. Since the bear market began in August 1992 the market is still around half the level of its peak in December 1989. Investors seeking value have scrambled into more attractive markets, such as Hong Kong and other ''Tiger'' economies, resulting in life insurers weightings plunging to a 10-year low, and net outflows from investment trusts. In the final quarter of last year the market was again wracked by uncertainty leading some wags to suggest that the then all-conquering Hang Seng Index's march towards 12,000 would cross the Nikkei as it fell below 16,000. But four months later the Hong Kong market got the jitters over the threat of an interest rate rise and uncertainties over whether the property price bubble is about to burst. Mr Makino believed that a savage round of cost cutting in Japan's corporate sector would help lead to a rebound in profits. He said: ''Margins are well off their highs, but a cyclical recovery teamed with cost cutting could give earnings a tremendous boost. ''Companies are making massive cost cuts and the whole idea of Japanese companies being unable to cut costs because of lifetime employment is simply not true.'' For example, raw materials account for around 75 per cent of car companies costs. A one per cent cut in costs is equivalent to the sector's operating profit last year. Mr Makino said: ''Nissan is cutting eight per cent off their raw materials and Toyota around 15 per cent over the next three years. Operating profit was down 64 per cent in the first half and only six per cent in the second. ''We are experiencing an economic recovery. It is not a strong recovery but it might not have to be if they continue to be serious about costs. In the next half of the fiscal year sales will be down a couple of per cent but operating profit should rise by 80 per cent due to a lot of cost cutting.'' Kleinwort Benson estimates that just a half per cent increase in revenue could lead to a profit rebound of 35 per cent. Mr Makino added that he had valued stocks using several different yardsticks - such as price-earnings ratio and dividend yield - and believed they are cheap. This is despite the economy being unlikely to achieve growth of one per cent this year following zero growth last year. He said: ''The market has made up some ground in the past four months but it is still very cheap compared to where we have been historically. It has lots of upside. People are so overwhelmed with cyclical negatives that they look past cyclical positives.'' Jardine Fleming's chief economist in Tokyo, Richard Werner, is less enthusiastic about the economies' immediate prospects but believed investors should be ready to move. ''My message to investors is to wait one more month and then make a decision. At the moment it is a watch. But get ready to get in,'' Mr Werner said. He believed the Japanese Government's preparedness to reinflate the economy by increasing spending was the key. ''The banks are not creating liquidity because they are in big trouble. It now depends on the government re-inflating the economy.'' Mr Werner believed that on current performance the economy would be struggling to grow by half a per cent. ''If the government stimulates the economy then we have some signs of around one per cent. But I am not quite convinced yet. The good news on the stock market is that the downside is limited because the government will simply not allow the collapse of the economy. ''As soon as the government wants to it will engineer the recovery. It will be able to do so in a short time period but it is impossible to say when,'' he said. Mr Makino believed smaller companies funds were a good barometer to economic recoveries. The Micropal table shows how the sector's leaders and laggards have performed over the past 12 months. He said: ''Smaller companies tend to operate in a niche or a single industry and do not need the entire economy to turn around to post an improvement in performance.'' G T Management marketing director Michael Yuen cautioned investors about to rush into the market. Mr Yuen said: ''Japan is at the bottom of the cycle, or is very close to the bottom. Both have limited down side. We increased our weighting in the first quarter as it picked up but the situation has not improved that much. We are not too excited.''