Japan once again seems to be coming out of the economic doldrums. Although there are still problems ...
Japan once again seems to be coming out of the economic doldrums. Although there are still problems with deflation, companies have been restructuring and are awash with cash as economic conditions seem to be improving.
Jeff Atherton, director of international equities at Insight Investments, says: "Despite the mixed economic news we are still positive on Japan. We have been impressed by the corporate sector and the restructuring processes will go further than most people think. The outlook for corporate profit growth is good."
Presently, Insight is favouring companies that have been out of favour in the past. NEC is one such example. The company used to be unfavourable to investors until it sold its loss-making semi-conductor business. NEC has also increased its stake in the more lucrative software business that has improved valuations for the company.
Atherton believes the Japanese small-cap story has finished and finds the most value in the larger top 200 companies. He thinks investors will switch back to large caps as the news flow is more positive and valuations in smaller stocks are nearly as high as the larger.
The Japanese Tankan index of business sentiment indicates the financial situation of large enterprises is improving, along with the lending attitude of banks.
However, Chisako Hardie, manager of the Scottish Widows Investment Partnership (SWIP) Japanese Small Companies Fund, feels there are good opportunities in the smaller companies market. Smaller companies are generally poorly covered by analysts and are consequently often left significantly undervalued, creating good investment opportunities.
According to Hardie, corporate Japan has built up an unprecedented cash surplus in the past few years and how this money is spent will influence strongly both the Japanese economy and stock market.
Atherton says: "The corporate sector is cash rich and there have been increases in capital expenditure and dividends. There have also been some signs of increases in wages. Property has been rising for the first time in 17 years. Bank loans have been written off and it looks like the banking problems are behind them."
Corporate Japan's total annual cash surplus between 2002 and 2004 was ¥100 trillion and much of this is still available for capital expenditure, mergers and acquisitions and dividends.
Hardie thinks this money could be invested in not only the machinery and machine tool companies, but equipment makers, supply distribution centres, new shops and offices and could also lead to higher demand for IT equipment.
"Merger and acquisition activity would re-organise sectors in the Japanese market, which could improve the pricing power of quality companies. This should, in turn, help the Japanese economy out of deflation. There are still a large number of inefficient players in certain segments of the Japanese market such as real estate and retail. Acquisitions are likely to increase in these sectors in the near future," says Hardie.
Haydn Davies, chief economist at Barclays, thinks Japan appears to have passed its low point, and activity in China now seems to be reaccelerating. A pick-up in Japanese foreign machinery orders suggests that overseas demand has already begun to recover.
According to Davies, last year's recovery in household spending proved short-lived because wages began tumbling again. However, Davies now believes wages have stopped falling and employment is at its strongest in three years. Finally, there are tentative signs that, at least in Tokyo, land prices have stopped falling for the first time since 1991. Davies feels the prospects look favourable for a recovery in household spending and a broader-based improvement in the economic climate.
However, Davies warns the fragility of the economic climate is also likely to hold back the Japanese yen. While the Japanese rates remain stuck at zero percent, the yield on the currency is becoming an ever-greater deterrent to investors.
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