With the Japanese government missing its best chance of resolving the banking sector difficulties...
With the Japanese government missing its best chance of resolving the banking sector difficulties, the probability of real change in Japan is less than ever.
In a climate of policy paralysis and poor fundamentals, I think the market is likely to drift lower. However, the drift is unlikely to develop into a collapse unless there is some unexpected external crisis.
The market is likely to drift lower with news of the government failing yet again to put an adequate reform programme together.
Given that all previous valuation levels have been broken and uncertainty regard- ing projected earnings, it is difficult to forecast when or at what level the market will bottom.
However, it is unlikely that there will be a financial crisis and the downside risk should be fairly limited. The negative factors are accumulating. The combination of a reformist Prime Minister Junichiro Koizumi and a supply-side economist Heizo Takenaka was unable to push through reforms past the resistant old-guard Liberal Democratic Party members. As a result the process is likely to take three-to-five years, during which time the economy will probably stagnate.
There is little indication of progress on the other policy fronts, with the government reluctant to consider further fiscal stimulus. Tax cuts for the next fiscal year are only expected to be of the order of ¥1 trillion.
Given the lack of progress on resolving the banks' bad debts, there is even less prospect now of the government privatising the Public Highway Corporation or the post office or materially reforming the tax system.
The economy is showing signs of slowing with the August leading indicator falling below 50 (the cut-off between recession and growth) for the first time since December last year.
Consumer confidence is falling as is industrial production. However, as the recovery was so anaemic I would anticipate that the expected recession will be modest too.
The supply/demand dynamics of the market are not positive. Foreign buying has been the key prop for the Japanese market over the past 10 years.
Foreigners have bought ¥24.8 trillion net of Japanese stocks over the past 10 years. They now own 18% of the market, and account for 54% of turnover. There would seem to be little prospect of foreigners buying, given that the original impetus for this growth, especially among the US funds, was the increase of the global funds under management.
The Japanese corporate pension plan sponsors, despite being below their benchmark weights, are showing little inclination to invest.
The willingness of the authorities to intervene and historically low valuations are the main remaining props to the market but these are unlikely to be sufficient to put a firm bottom to the market and so the market is likely to drift.
To summarise, the current policy paralysis and weakening economic outlook will result in the market drifting. I will continue to focus the funds on investing in quality companies with strong balance sheets.
Downside risk limited.
Historically low valuations.
Any recession likely to be modest.
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