By Denis Clough, manager of the Schroder Tokyo fund and director of investment management It is of...
It is often said that Japan dances to a different tune. Since 11 September, markets around the world have bounced but Japan less so. Military action in Afghanistan has been successful and lower worldwide interest rates have improved economic prospects but Japan's focus remains on its own structural problems and mixed economic data. While faith in monetary policy to power a global recovery exists, attention is fixed closer to home.
Recent events such as the surprise collapse of insurer Taisei Fire and Marine dragged the sector lower but the wider implication of this shock announcement is clearer evidence of poor disclosure in the financial system and the weakness of risk management. This, and other pressures on the system, led Standard and Poor's to downgrade their rating of the country's government bonds to AA.
Despite this, many Japanese businesses appear attractively valued but stock selection is crucial. Value abounds because investor expectations are so low. This, though, is ultimately worthless if never unlocked.
Any or all of the big themes sweeping through Japan today ' government reform, de-regulation and corporate restructuring ' could eventually serve as catalysts to release this, which should boost sentiment, sending markets higher. Share valuations have fallen to near historic lows and good long-term opportunities exist for those willing to look to the future.
Japan's prime minister, Junichiro Koizumi, talks of reform and is popular among an electorate keen for restructuring and the tackling problems at some of the country's banks. There is now a chance the right policies to restructure the country could become law. Meaningful reforms could restore the hope of those who have been burnt before. The market is already assuming that he will fail, so the downside risk looks limited.
Government action would encourage many Japanese companies to continue their own restructuring. Many have already been doing this but more can be done.
Corporate restructuring is very important to investors who want leaner and fitter businesses thanks to better practices and smaller workforces. Some restructured businesses have seen profits jump and, perhaps more importantly, now have a sound base for delivering accelerating growth in the future. Many more stand to gain. While Japan's largest companies have already benefited from restructuring, smaller companies, after a slower start, are beginning to wake up.
While large companies in Japan are undervalued, there is even more value among those smaller companies beginning to change for the better. Improved returns on equity over the past two years show what can be achieved from restructuring.
Of course, the Japanese economy is not going to take off tomorrow. Although there has been some fiscal easing by the Bank of Japan, interest rates leave little room for manoeuvre.
While the global economic recovery may have been delayed by the US terrorist attacks, it has not been de-railed. When it appears, it should eventually lead to positive returns from this growth-sensitive market.
Downside risk is limited.
Equities attractively valued.
Global monetary policy to boost growth.
Little potential monetary stimulus.
Market expects reforms to fail.
Restructuring lags West.
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