Why Japan Market Chaos Worries U.S.
As the Japanese stock market continues its spectacular plunge, many folks on Wall Street are at once smug and relieved: smug that the Japanese market finally has stopped defying gravity after all these years and relieved that the debacle there hasn’t pulled down U.S. stocks.
But the lower Japan goes, the higher the worry level here. Many experts see a growing risk of spillover damage to U.S. stocks and other assets if Japan goes into a free fall over the next few weeks. And the danger of such a panic may be greater than anyone could have imagined even a month ago.
One widespread myth is that there’s some fundamental strength supporting U.S. stock prices as Japanese stocks crumble. While the Tokyo exchange’s 225-stock Nikkei index has plunged nearly 21% this year, the Dow Jones industrial index is off just 0.5%--and the Dow has been rising in recent weeks as the Nikkei has taken its worst hits.
From those numbers, one would assume that the United States has the stronger outlook for economic growth and that Japan has the weaker outlook. Of course, just the opposite is true. So it isn’t inherent economic strength or weakness that are driving stock prices there or here.
Instead, Japan is being ravaged by fear of the unknown: Political leadership seems paralyzed, and the Bank of Japan’s campaign to raise interest rates--largely to halt a slide in the yen’s value--seems too little, too late. A full-point rise in the bank’s discount rate Tuesday, to 5.25%, failed to reverse the yen or the Japanese stock market.
The net effect is that U.S. stocks are winning by default, not for fundamental reasons, many experts argue. Investors here who bet on a rising U.S. market “have gotten it right for the wrong reason--the yen,” said Jeff Bahrenburg, Japan market strategist for Merrill Lynch & Co. in New York.
As the yen plummets and the dollar strengthens, U.S. investments look more appealing to Japanese investors and other foreign investors. If a Japanese investor bought $1 worth of stock here when it took 140 yen to purchase a dollar, that same $1 worth of stock now is worth 154 yen. And if the stock has since risen in value, it’s gravy for the Japanese investor.
Wall Street traders say they haven’t seen a dramatic surge of Japanese money into U.S. stocks in recent weeks, but they say there’s no question that some of the yen from stock sales in Japan are making their way to the United States. “The way the currency is going, it just makes sense for them to hold dollar-denominated investments,” said Rodd Anderson, a trader at Shearson Lehman Hutton.
On Tuesday, a strong rally in U.S. Treasury bonds was attributed partly to buying by Japanese investors who are convinced that the yen is headed still lower.
Bahrenburg argues that Japanese investors’ disenchantment with their own markets is likely to bring even more money to our shores. Japanese corporate investment trusts, a major source of fuel for their stock market, “are very underinvested in foreign securities,” he said. Those rich accounts have just 8% of their assets in foreign stocks and bonds now, versus 15% early in 1987, he said.
If the yen continues to weaken, the lure of overseas investments may prove overwhelming for the Japanese. And one key attraction of U.S. stocks is that they are far cheaper than Japanese stocks relative to corporate earnings. The average U.S. stock is priced at about 13 times last year’s per-share earnings. In contrast, many of Japan’s biggest stocks sell for about 20 times earnings even after their declines this year--and those are the Japanese stocks that are considered bargains. (The average price/earnings ratio for major Japanese stocks is 48.)
What seems to translate into great opportunity here because of Japan’s chaos, however, also is fraught with risk for U.S. markets. The greatest risk is that Japan’s market simply melts down.
The betting now is that Japanese stocks will continue to fall but in an orderly fashion. George Hersh, Japan market strategist for Daiwa Securities in New York, said the next “support” level for the Nikkei is around 28,000, or 9% below Tuesday’s close of 30,807.
But could the decline rapidly turn into an uncontrolled selloff? No one wants to think about that. Most experts take the Bank of Japan’s view: that what’s happening to Japanese stocks is a normal correction after nearly a decade of superheated gains. In fact, one of the bank’s arguments in raising interest rates, besides defending the yen, is that speculation must be wrung out of Japanese stocks.
As rational as that may sound, however, Hersh notes that many big investors in Japan are terribly distressed by the paper losses they’ve suffered. Those losses are calling into question the strong buy-and-hold philosophy that has always guided Japanese investors, Hersh contends. “They’re asking, ‘What should we do now?’ ” he said.
If the selling spirals out of control, the United States could quickly feel it. A meltdown could produce massive paper losses in Japan that could force investors there to sell overseas assets to raise capital. And U.S. assets would be easiest to dump.
Even without a meltdown, a severe enough decline in the Japanese market could leave many Japanese investors feeling far less wealthy. “And if they feel less rich, we’ll experience less in direct investment here--not just the West Coast but the entire country,” said Kathleen Cooper, economist at Security Pacific Corp. in Los Angeles.
Finally, the longer-term risk for the U.S. stock market is worth keeping in mind, too: Once the Japanese market stabilizes and the yen stops falling, our market no longer will win by default. At that point, U.S. stocks will have to stand on their fundamentals. And if our interest rates continue to rise, and corporate profits continue to slump, the fundamentals may prove very rickety.
JAPAN’S WOUNDED STOCKS
How some Japanese stocks have fallen since year’s end. These are American Depository Receipts traded here, representing the actual shares trading in Tokyo.
Dec. 31 Tues. Stock close close Change P-E* TDK $39 3/4 $36 1/4 - 8.8% 25 Hitachi 105 1/2 92 3/4 -12.1% 20 NEC Corp. 65 1/2 56 1/2 -13.7% 43 Honda 25 1/8 20 1/2 -18.4% 19 Sony 60 1/2 48 1/4 -20.2% 22 Fuji Photo 62 1/8 47 1/8 -24.1% 15 Matsushita 164 122 1/2 -25.3% 17 Toyota 35 1/4 26 1/4 -25.5% 16 Canon 64 45 1/2 -28.9% 23 Mitsui 192 3/4 114 1/2 -40.6% 26 Nikkei avg. 38,916 30,807 -20.8% na
* stock price/earnings ratio based on most recent reported 12 months earnings per share
JAPAN VS. OTHER MARKETS
So far, Japan’s market woes have had little effect on other world markets. How some key stock indexes have fared this year:
Percentage change Country/index 1989 Year to date W. Germany/FAZ +35.2% + 8.3% Singapore/Straits Times +42.6% + 5.6% Hong Kong/Hang Seng + 5.6% + 1.6% U.S./Dow industrials +27.0% - 0.5% Australia/All Ordinaries +10.9% - 3.2% Britain/FTSE 100 +35.1% - 6.7% Japan/Nikkei +29.0% -20.8%
