The recent rally in global equity markets has thrown up some interesting anomalies, with the Nikke...
The recent rally in global equity markets has thrown up some interesting anomalies, with the Nikkei up significantly less than the major US and UK indices since the start of March this year. Earlier this year, the Nikkei fell to a 20- year low and for several weeks traded below its 44 year moving average.
The Japanese market had fallen by a similar amount in the months immediately before the war in Iraq and also since the bursting of the Nasdaq bubble and subsequent recession in the US in 2000/2001. Being a net oil importer, Japan was and is, admittedly, very vulnerable to the prospect of a period of sustained oil price strength.
The valuation premium, which has been attached to the Japanese market, has all but disappeared and in our view Japan is cheaper than most developed markets. At the beginning of March, before the most recent rally began, the Nikkei was trading on around 18 times this year's earnings, compared to an estimate of 25 times in the US.
In addition, Japanese earnings growth in 2003/2004 may significantly exceed current expectations if there is any pick-up in global growth. If growth does accelerate in the second half of this year and next, then we believe the Japanese market is probably trading closer to ten times rather than 18 times this year's earnings.
Thirdly, the pick-up in overall market profitability is a symptom of a broader trend that is ongoing in Japan. Restructuring has become a way of life for many companies in Japan in the last few years and one which can only spread, should the recent increase in economic liquidity lead to a dissipation of deflationary pressures. Recent analysis has produced a list of more than 50 companies who are seeking exponential growth in profits, despite falling sales. This puts Japan well ahead of many German companies and even some North American companies in the race to survive.
Overall, the current outlook is probably as bright as it has been for 10 years. Chuck Lambert, a long-time veteran of the Japanese market both bull and bear, recently wrote: 'The Topix index has had five or six big rallies since 1990. However, most of the rallies were sudden changes of direction, usually spurred by an event such as an economic package or a bank bailout, and the rallies thus burned out rather quickly.
The dotcom rally, which began in March 1999, was preceded by a longer base than usual, but the current recovery is coming off an even longer base and from a lower level.
The 13 week and 26 week moving averages have had time to flatten, and both have now moved into gradual uptrends ' the weekly chart for TOPIX has had its most promising recovery pattern since the great bear market began in 1990.'
Successful contrarian investment depends on identifying an asset which is out of favour. The fact that the Nikkei is trading below its historical average and that earnings growth may exceed current expectations means there are good opportunities in the market.
Attractive valuations available.
Earnings growth may exceed expectations.
Positive restructuring continues.
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