Where the economists were right was in thinking that the key to the turnaround in Japan would be a r...
Where the economists were right was in thinking that the key to the turnaround in Japan would be a recovery in confidence. The problem is that confidence is the least scientific and most subjective of the variables with which they have to contend
Based on the facts in their famous rear view mirror, economists prudently stuck to the slow lane. With no positive numbers behind, they couldn't see the break in the gloom ahead. Less encumbered by the rigours of the Miserable Science equity investors, on the other hand, faced with the dark tunnel ahead, donned their sunglasses and stepped on the gas in chase of the light at the end, the Big Idea
As a result, the Tokyo First Section Index is up nearly 40% this year. The real party, however, has been for those investors in smaller companies, with the Second Section Index up around 115% and the JASDAQ index up around by 160%. The strengthening yen has served only to sharpen the cocktails
The big idea is 'New Japan', a catch-all phrase that embraces both a type of company and a mindset. 'New Japan' is young: young managers and young companies. 'New Japan' sells services and ideas: it is healthcare, high fashion, convenience shopping, mobile telephones and the internet. 'New Japan' is clean with no factories and new (rented) offices. 'New Japan' has grown from being the pursuit of reasonable price-earnings ratios to the quest for growth. New Japan is tomorrow
The problem is that 'New Japan' remains very small and everyone wants some. With more and more institutional investors joining in the search, one of the richest areas has been the new issues market, but with the lion's share going to domestic retail investors, overseas investors have been forced to fight for the tantalising scraps. Consequently, 'New Japan' has got very expensive. Several growth companies are now trading on price-earnings ratios of over 100 times, and PEG ratios (price-earnings/growth) of over four times. Many little, young companies are going to have to grow up very quickly to justify this kind of valuation
'Old Japan' is everything else. 'Old Japan' is old: old companies, old managers. 'Old Japan' makes things. 'Old Japan' is dirty (freehold) factories in the suburbs. 'Old Japan' is measured in terms of assets and book values. 'Old Japan' is today. Even after the recent market rises, perfectly viable 'Old Japan' companies with recovering earnings can still be bought for significantly less than their book value
Economic recovery remains predominantly anticipated rather than realised. Just when the economic figures are catching up with sentiment, the money for fiscal packages is running out, exporters are wincing at the strength of the yen and the pain of restructuring is threatening to quash the nascent consumer recovery
At Henderson Investors, however, we believe that recovery, albeit modest, will be sustained. Far more exciting, however, is the outlook for profitability which looks set to leap on a combination of cyclical recovery, restructuring and a more benign tax environment
We are not alone. Nomura Securities, for example, is forecasting record consolidated profits for its 400 monitored companies (excluding financial companies) for fiscal year 2000
The irony is that if the economy is to continue to recover in the near term, much of the work will have to be done by 'Old Japan'
While we continue to highly evaluate 'New Japan' companies for their ability to seek and exploit new markets, we are also looking for companies in 'Old Japan' where management shows the capacity to restructure good businesses in order to extract profits
Jeremy Hall is a fund manager at Henderson Investors
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