By William May, head of Japanese equities at Neptune Investment Management Japan's current econo...
By William May, head of Japanese equities at Neptune Investment Management
Japan's current economic prospects depend to a greater degree than usual on the US. In June 2002, the Federal Reserve published a paper entitled 'Preventing deflation: Lessons from Japan's experience in the 1990s.' In it, they concluded 'when inflation and interest rates have fallen close to zero, and the risk of deflation is high, stimulus ' both monetary and fiscal ' should go beyond the levels conventionally implied by baseline forecasts of future inflation and economic activity'.
The paper suggested firmer action should have been taken in the 1991-1995 period and, in particular, interest rates should have fallen faster and fiscal policy should have been even stronger and better directed.
These conclusions are central to present US monetary policy and explain the background to the greatest post-war stimulus ever applied to the US economy. By contrast, Japan continues to languish in a condition where conventional monetary instruments have been largely exhausted. However, the new Bank of Japan governor Fukui has shown signs of greater responsiveness than his predecessor.
In May, the Ministry of Finance spent ¥3.98 trillion ($34bn) intervening in the foreign exchange market to depress the value of the yen. Intervention on this scale, which was a record for a single month, was decided by the ministry but implemented as usual by the Bank of Japan and may not have been fully sterilised in order to attempt to provide additional stimulus.
Currently, the domestic economy continues to record an insufficient rate of GDP growth forecast at 0.7% this fiscal year and 0.4% next and the banking system continues to cry out for a better long-term solution than the large-scale bailout recently applied to Resona Bank.
With a March 2004 P/E ratio of 18.9 times for a universe ex financials, the Japanese stockmarket is undoubtedly cheap. However, it has long required a catalyst which, because of the inadequacy of Japanese policy-making, was never going to be provided domestically.
A crisis has been needed to concentrate the minds of Japan's politicians, but one of the few credible assertions of prime minister Koizumi has been his determination to avoid a financial crisis at each half-year and fiscal year-end.
Corporate profits rebounded 46% to March 2003 and are expected to rise by a further 15% in the current fiscal year ending March 2004. Ultimately, an improvement in demand is necessary to sustain profits growth.
The US accounts for 25% of Japan's exports but a significant proportion of the goods shipped to Asia (44% of exports) are subsequently re-exported to the US. Thus, moves by the Fed to re-ignite growth are crucial for Japan, which continues to struggle with deflation.
Given a second-half economic recovery in the US, Japanese export growth, which is expected to decline 1.8% this year, should revive. Companies with exposure to that market should see welcome benefits and this should underwrite further advances in the stockmarket.
US recovery would help exports.
Corporate profits have improved.
Market multiple historically low.
Deflation still plaguing domestic economy.
Banking crisis unresolved.
Japanese policy-making remains poor.
Tapered annual allowance headache
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