By Fraser Laird, head of Japanese equities at Abbey National Asset Managers We are faced, once aga...
We are faced, once again, with a looming crisis in Japan, caused by a combination of a weak economy and banking system, and a failure at policy level.
Again, investors are left wondering whether there will be a proper resolution this time around or a reversion to type, which can be categorised as a muddle-through philosophy.
All of which is rather galling. While the election of Koizumi last year was never likely to transform the policymaking process wholeheartedly, expectations were raised that some much-needed refocusing of priorities would be achieved.
Furthermore, with his overwhelming popularity, it seemed likely that internal resistance to change would subside, at least temporarily, providing a window of opportunity for policy action. Alas, Koizumi's agenda turned out to address only some of the key issues and has in any event been rather derailed by an imploding economy. Attention has subsequently turned to the prospect of a debilitating deflationary spiral and a collapsing banking sector.
The net effect sees investors left struggling with a strong political element in their assessment of the market and this makes valuation decidedly tricky, if not impossible.
The hurdle rate for Japan to re-emerge as a growing economy has certainly been raised as its fiscal position has been progressively eroded and orthodox monetary policy has been founding wanting. This would suggest that policymakers might look to more drastic alternatives to boost the economy as well as their need to recapitalise the banks.
Such drastic policy moves, which are only now being given serious consideration, add to uncertainty. Investors, of course, hate uncertainty.
A good example is the possibility of deliberately engineering a weaker yen to boost activity. Investors must decide how much of their portfolios to hedge and by how much they should raise their weightings in yen-sensitive sectors, such as automobiles and consumer electronics.
Should investors adopt a defensive portfolio stance? I would argue against this. While there is a very real possibility of lower share prices in the near future, such a collapse has historically acted as the catalyst for action and share prices have then made a rapid recovery. Getting the timing right under these circumstances is never easy. On the other hand, the market's fall has already brought valuations down to modest levels and company forecasts for the current fiscal year are now looking realistic.
An increasing number of Japanese companies are acknowledging that they need to restructure their businesses going forward and this should be value enhancing. In addition, technology companies, which comprise a significant proportion of the market, are now experiencing better trading conditions or at the very least a bottoming of demand for their products; a relatively weak yen is also supportive here.
Finally, one must consider the potential impact of high liquidity levels that exist globally as a result of central bank action and low real economy demand for credit. If money does flow into Japan, it will probably be targeted at leading blue-chip names rather than defensives.
Market valuations modest.
Corporate earnings realistic.
Corporate restructuring accelerating.
Banking sector near collapse.
Dangerously weak banking system.
Drastic policies needed to boost economy.
Among the most shorted stocks in the FTSE 100
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