In 2005, Japan was the best performing stock market of the major economies, rising by 43.5% and fini...
In 2005, Japan was the best performing stock market of the major economies, rising by 43.5% and finishing at its highest level since September 2000 in December last year. Although returns may not be as high as last year, Japanese equities are expected to deliver better returns than most markets again in 2006.
There are a number of reasons why Japanese equities should continue to rise, mainly due to an improving domestic economy and a government eager to reform.
In the face of opposition, prime minister Junichiro Koizumi has attempted to implement significant reform over the past few years, mainly to rid the state of bureaucracy and operate a more decentralised government.
Since his re-election last September Koizumi has been pushing further ahead with his plans to reform the postal service, which has proved positive for equities and, in particular, for banking and financial stocks.
Beyond reforming the post office, Koizumi has set out his broader agenda, which includes smaller government, a reform of the medical system and the return of the budget deficit to a surplus by 2010.
The continued painful reform and restructuring of Japanese companies will also play a part in supporting equities. The ongoing corporate restructuring of Japan Inc is beginning to make companies more profitable and more efficient than they have been for years.
The benefits of this restructuring have already begun to feed through into corporate earnings announcements. Several major players in banking and consumer electronics, including Nomura and Toshiba, have seen profits rise significantly in recent quarters.
As companies reform and become more profitable, they are also beginning to boost their workforce. Testament to this is a drop in unemployment to 4.4%. Workers have seen a steady growth in their wages because companies can now afford to pay more for the most skilled labour.
The upshot of these improving labour market conditions is that households have become more confident and are willing to spend. Indeed, for the first time in 10 years, domestic demand is driving the economy rather than exports.
Growth in the population's spending in the fourth quarter was a significant 7.3%. So, while exports are still contributing to economic growth, domestic demand has taken over the reins as the key driver of growth.
The imminent return of inflation will also boost investors' wealth and encourage spending. Land and other asset prices began to rise from the middle of 2005, which has put Japan back onto a path of asset price and wealth reflation.
Reflation has been shown to be a powerful force in lifting economies out of the doldrums. It can help boost consumer demand and spur a wave of construction and related demand, and, in Japan, is likely to encourage households to spending their huge cash savings.
All of this means that Japanese equities are likely to perform well this year, with both foreign and domestic investors expected to increase investment in the country as they see the economy improve and better returns to shareholders.
Best-performing major economy stock market
Reform and restructuring supports equities
Imminent inflation return will also boost investors' wealth and encourage spending
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