Many investors remain skeptical and have reservations about recent upturns in the Japanese stock market. The reason behind this skepticism is that each rebound in the last decade has been illusionary and transient. However, the major factors contributing to recent upturns are in fact substantially different from those of the past.
During the long-term bear market in the 1990's, Japanese equities staged three short-lived recoveries in 1992, 1995 and 1998. Investors misled by these three transient rebounds have since plunged into an abyss. During the period in which these three "traps" took place, the Japanese government has invariably implemented expansionary fiscal measures while the fundamental economic, industrial and corporate situations in Japan have not substantially improved. After each rebound, the Japanese stock market again plunged, hitting a major bottom in March/April 2003, the biggest since last decade.
Having gone through painful reforms for over a decade, Japan is beginning to see the fruits of her labour. Firstly, following the recovery of the global economy, Japan has begun to improve in her exports. In the fourth quarter of 2003, exports increased by 32% year-on-year in volume terms, with those to Asia (to China in particular) accounting for a significant portion of the growth. Since the Japanese government ceased to adopt expansionary fiscal measures a couple of years ago, private corporations are the principal engines behind recent growth. Meanwhile, Japanese companies' private capital expenditure (capex) is set to recover for the first time since 2000.
STRUCTURAL CHANGES POSITIVE FOR EQUITY MARKET
In addition to the cyclical factors, structural changes are another concurrent favourable factor for the Japanese stock market. Japan's major banks have finally put the worst of their bad-debt problems behind them. The non-performing loan workout process has finally reached a critical turning point. Operating profits appear likely to exceed credit costs during the current fiscal year, leaving aggregate net profits in the black for the first time in eleven years. Concomitant to the recovery of domestic economy, the problems of deflation and excess capacity have been alleviated. Moreover, selling related to the unwinding of cross-held shares appears to have peaked and the crossholding ratio for the market is estimated at around just over 20% (compared with around 50% ten years ago). This trend has also led to improvements in corporate governance as companies can no longer ignore the interests of the shareholders.
Micro-level factors have played an even more important role. Japanese firms have undergone a restructuring and balance sheet clean-up during the last decade and are now back on track with profit growth. According to Toyo Keizai (a leading financial publication), Japanese companies (Topix ex financials) are forecasting a 0.8% year-on-year gain in sales and a 19.0% year-on-year increase in recurring profits for the fiscal year ending March 2004. The low level of expected sales growth highlights the success of companies' efforts in restructuring and streamlining their business, cutting fixed-costs, exiting unprofitable businesses and refocusing on their core competencies.
RISING CURRENCY NOT A BIG CONCERN
Despite the fact that the ongoing Yen strength may have an impact on the competitiveness of companies with high levels of overseas exposure, most companies have already moved their significant production capacity offshore and the cost-effectiveness gained there can offset the adverse effects brought forth by the appreciation of the Yen. Another micro-level factor is the normalisation of valuations. During the past recoveries in 1992, 1995 and 1998, Japanese equities still looked expensive in relation to other developed markets. According to I/B/E/S, Japan's perspective price-to-earnings now stands at around 17x, a level comparable with the US and Europe but significantly different from their previous valuations. All these factors contribute to an optimal upside potential of the Japanese market.
These concurrent cyclical, structural and micro-level factors serve as a strong boost to the Japanese equities and render them tremendously attractive to international investors. Besides, a number of factors that have previously restricted the upside potential of the Japanese market have been or are in the process of being removed, many analysts hence hold that the long-term bear market of over ten years of duration in Japan could have hit a major bottom in March/April 2003.
CONCLUSION
Although the ongoing uptrend of the Japanese market depends on peripheral factors such as recovery of global economy, there are undeniably favourable fundamental changes in Japanese equities. These changes are essential factors which investors should neither overlook nor mix up with previous short-lived rebounds. As such, the above arguments point towards a positive outlook for Japanese stock prices in the long run. It may perhaps be apt to compare Japanese equities to a newly recovered patient who has just put down his walking stick. It remains unknown as to whether or not he can run again; nevertheless, he is making encouraging progresses in his recovery and his reintegration into the community.
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