Japan Inc. Fades, but Stock Ideas May Still Abound

If Japan Inc. is becoming Japan Etc., are Tokyo stocks more attractive or less?

That’s the question facing investors as Japan’s ruling Liberal Democratic Party faces ouster after 38 years in power. The LDP’s decline is another sign that the nation is weaning itself from the single-minded industrial policy that helped create Japan’s economic miracle.

That should mean a better life for many Japanese. Long-suffering urban consumers, for example, would benefit from a more open economy that filled the needs of working people--instead of sacrificing their comfort for the national export machine, the diktat of Japan Inc. since 1945.

But a Japan Etc. that grows more like the relatively open economies of America and Europe also would mean that picking stock winners, and avoiding losers, becomes a tougher game.

So far, investors’ response to the LDP’s fall has been controlled panic: Tokyo’s Nikkei stock index plunged 592.11 points to 19,212.43 on Monday. The Nikkei recovered 325.87 points Tuesday, but at midday today was off 108.42 points to 19,429.88.

Investors had sensed trouble well before this, because the Nikkei’s spring rally ran out of gas early this month just over the 21,000 mark.

The Nikkei’s surge from 17,000 in February had been fueled largely by foreign buyers on the belief that the 3-year-old Tokyo bear market had run its course and that Japan’s economy and corporate profits were primed to recover later this year.

Lower interest rates and a massive public spending program were expected to bolster the economy, despite mounting pressure by Japan’s chief trade partners to limit further growth of the country’s still-powerful export machine.

Now, with the LDP forced to call new elections and the shape of the next government thus unknown, investors fear that the public spending plan and other potentially economy-boosting steps may be slowed or put on hold entirely.

But Steven Nagourney, global market strategist at Lehman Bros. in New York, argues that the change in Japan’s economic course is all but irreversible. With little help from a sluggish global economy, Nagourney says, “Japan’s economy will not be able to grow at more than a 3% annual rate if it can’t get domestic consumption up.”

Thus, he says, the next government will have to follow policies that encourage domestic spending and raise the living standards of working people.

Getting there will take even lower interest rates and maybe a tax cut, Nagourney figures. Either step should benefit the Japanese stock market, he notes. Likewise, a policy shift that invites cheaper imports would benefit Japanese importing firms, home builders, discount retailers and other key consumer sectors of the stock market.

The flip side, of course, is that rising foreign competition and a de-emphasis of exports could hurt equally important market sectors, such as Japan’s electronics giants.

But management guru Peter Drucker, writing in the spring issue of the journal Foreign Affairs, suggests that the demise of Japan Inc. could in the long run benefit even some of the exporters.

“If there is no consensus policy and no administrative guidance, individual Japanese companies should become tougher competitors on the world market,” Drucker argues. “Just as some individual companies in the West have prospered by doing things entirely their own way, so some Japanese companies can be expected to prosper greatly, by doing things their own way rather than the ‘Japanese way.’ ”

But therein lies the challenge for investors: Which Japanese firms will lead Japan Etc.?

Picking the right stocks, of course, is what market pros are paid to do. The overriding problem that many of them have with Japanese stocks today is that the market still appears dramatically overpriced compared to the rest of the world. The typical Japanese stock is priced at about 60 times last year’s earnings per share; the global stock average is between 20 and 30 times.

“If Japan is becoming more like the U.S. and Europe, why should I pay so much more for Japanese stocks?” asks Jean-Marie Eveillard of the SoGen International Fund in New York.

Christian Wignall, strategist for GT Global funds in San Francisco, figures that kind of reasoning assures that the Tokyo market can’t explode higher anytime soon. At the same time, Wignall believes that global investors’ faith in Japan’s long-term economic viability will put a floor under the Nikkei, probably around 16,000.

In short, Wignall says, it doesn’t make sense to simply walk away from Japanese stocks, because there will be opportunities to make substantial money in Japan Etc. “But this is no big Japanese bull market,” he warns. As with the U.S. market and many others in the ‘90s, “people should have modest expectations.”