James Pulsford, manager of the Deutsche Japan Growth Trust Since September last year, newsflow in...
James Pulsford, manager of the Deutsche Japan Growth Trust
Since September last year, newsflow in Japan has generally remained poor and the equity market has remained depressed.
The past quarter has seen economic data in Japan getting significantly worse while government efforts to implement much needed structural reforms appeared to have stalled. Sentiment has also been undermined by rumours of a number of bankruptcies among the major banks.
Although recent economic data may have shown some improvement outside Japan, it is too early to say if this will provide sufficient stimulus to get the Japanese economy going again in the medium term. Given the weak state of the domestic economy, a strong sustained recovery in the US and Europe is probably required before any real upturn in Japan can begin.
It is difficult to see what will drive recovery in Japan other than external demand, as the domestic economy continues to suffer from deflation and private consumption is under pressure from rising unemployment, declining overtime hours and falling wages.
At the same time, deteriorating corporate earnings will restrain business investment, negative equity will limit housing investment and a ballooning budget deficit will prevent the government increasing public works spending.
Despite this, Prime Minister Junichiro Koizumi still has a very high popularity rating. The public clearly approves of his commitment to carry out widespread structural reform in both the government and economy.
Unfortunately, there has been very little progress in pushing detailed reform legislation through the Parliament and many of the key problems facing Japan, such as the massive bad debts still plaguing the banking system, have not yet been confronted.
Given the scale of the bad debt crisis in the banking sector and an economic background of recession and deflation, some very tough policy decisions need to be taken. It is doubtful, however, whether Koizumi will be able to overcome resistance from vested interests opposed to reform.
Against this political and economic background, it is not surprising that the equity market has performed poorly. Support for the market has come from valuations, which stand at historically low levels, but the past few months have seen a significant deterioration in valuations as a result of sharp declines in earnings forecasts.
At the time of announcing interim results in October and November last year, most companies revised down their official forecasts. The most savage cuts were from financial companies.
One should not get too bearish however, as domestic economic data is likely to bottom out in the first half of 2002 and corporate earnings should begin to stabilise and begin to rebound in the second half of 2002. The current weakness in the yen should be very positive for corporate earnings, offsetting some of the negative effect from the weak domestic economy.
Although we continue to look for opportunities within the market on a stock by stock basis, at the sector level, we have moved modestly overweight in technology, while maintaining underweight positions in the banking sector.
Improving global outlook.
Valuations at historically low levels.
Domestic data likely to bottom out in first half.
Attempts at structural reform have stalled.
Poor domestic demand.
Corporate earnings remain low.
Patience must be a watchword
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