Fund manager's comment |
Japanese equity market weakness continues to be driven by the absence of meaningful structural reform to tackle bank's bad loans in the face of deflation, coupled with the poor demand-supply situation for Japanese equities.
The underlying economy has held up surprisingly well over the past year, despite geopolitical risk and sub-par global growth. However, internal Japanese politics and the back-tracking on banking reform has damaged investor sentiment recently.
The Japanese economy struggled in the face of a resurgent yen, relative to the US dollar, until the middle of 2002, despite bouts of currency intervention by the Bank Of Japan (BOJ). This hindered exports to certain markets over the second half of the year.
Fortunately, Asian growth, especially in China, helped Japanese export performance, while the economy benefited from various government spending packages. This supported mildly positive growth in the last few months of 2002.
However, economic momen- tum has faded recently, with weakness apparent in consumer sentiment and income trends. Nevertheless, the February unemployment report was positive and consumption remains relatively firm as consumers continue to run down their savings.
While the latest Tankan survey suggests a further decline in capital expenditure, both exports and the trade surplus keep growing, reflecting Japan's comparative advantage in certain sectors.
A key unexpected impediment to growth, however, is the impact of the Sars virus on Asian growth. On the equity front, other issues are important. While fiscal year 2003/4 operating earnings are still expected to grow, albeit at a slower pace than in the previous fiscal year, the equity market has continued to decline.
On the one hand, the massive equity purchase operation begun by the BOJ last November, expected to last two years, won friends abroad because it was premised upon further reforms.
Instead, the failure to appoint a reformer as the new governor of the BOJ, the abandonment of mark-to-market accounting and the dubious capital increases for banks via privately placed preference shares in the first quarter of 2003 have been major blows to foreign investor sentiment. This has prompted large-scale net selling in recent weeks.
Aside from this, the demand-supply equation had been poor from the standpoint of foreign pension funds, which continue to decrease global equity weightings.
While traditional year-end liquidation of cross share-holdings has occurred, further selling pressure continues as pension funds prepare to repatriate state pension portions back to the government before next September.
Broadly speaking, the demand-supply equation affects larger capitalised stocks includ- ing financials. Our holdings are focused on domestic-oriented, fast-growing companies of smaller size, which are benefiting from deflationary trends and lifestyle trends such as increased leisure time.
Equity valuations are very cheap, however; and with correct identification of niche growth areas, it is possible to avoid the vagaries of the broader market.
Risk to growth from weak US economy.
Earnings estimates over optimistic.
Retreat by government on banking reform.
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