Is the economy really going to pick up after years of false dawns? Investors outside Japan think so....
Is the economy really going to pick up after years of false dawns? Investors outside Japan think so. Volumes on the Tokyo stock exchange hit record highs on successive days in the wake of Koizumi's recent re-election, largely thanks to buying by overseas investors. Enthusiasm has propelled share prices back up to levels not seen since early 2001. By contrast, domestic investors remain more cautious. Who is right?
We side firmly with the bulls. Despite its recent gains, the Topix still has further to run, and may reach 1,600 by the end of this year. But our positive outlook is not a response to Koizumi's recent re-election. Rather, our enthusiasm recognises that there has been a change in the Japanese economy and in the behaviour of Japanese companies.
To look at the economy first, Japanese GDP grew at an annualised 3.3% rate in the second quarter of this year. Unemployment is falling, and the new jobs being created are increasingly full-time posts, rather than temporary or part-time positions. Retail sales are recovering. Land prices in Tokyo have increased for the first time in 15 years.
But, while the prospect of self-sustaining growth in Japan is one reason for our bullish outlook, investors ultimately depend on corporate profitability. Here too, the picture is encouraging.
Firstly, China's emergence as an economic superpower has been a blessing for Japanese industry, rather than its destroyer, as some protectionists feared. Japanese companies operating in China have not only been able to take advantage of their neighbour's breakneck pace of economic growth and cheap labour, but many have equipped their factories with components made in Japan, so boosting corporate revenues and stimulating demand in Japan.
Secondly, cost-cutting across corporate Japan in recent years, while painful in social terms, has resulted in sharply increasing profit margins as global demand and revenues have increased. While this increasing profitability is, in itself, a good thing for investors, it has had other positive implications for Japanese stocks.
As margins have increased, an increasing number of Japanese companies have become able to pay their debts. The reduction of non-performing loans has left the banking sector's balance sheet looking significantly healthier.
Meanwhile, the unwinding of cross-shareholdings has allowed foreign investors to take a larger share of the Japanese equity market. In combination with imminent reforms which should expose Japanese companies to a greater threat of being taken over by foreign rivals, management teams are focusing on profits and share price returns.
There remain challenges for Koizumi and for the Japanese economy, but despite these we remain bulls, this time it is not a false dawn.
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