Rebound in Japan Would Shore Up Investors’ Faith
If the Japanese economy is re-accelerating--at long last--does that make the Japanese stock market a screaming buy?
Tuesday’s report that Japan’s gross domestic product shot up at a 12.7% annualized rate in the first quarter, sharply above expectations, was almost overshadowed by the still-unfolding Sumitomo Corp. copper-trading scandal. But over time, the Sumitomo debacle will amount to a mere blip. If Japan’s economy finally is emerging from its virtual depression of the last few years, however, the implications for Japan’s financial markets--and for the world economy--obviously are huge.
An economic recovery should bring a sustained rebound in Japanese corporate earnings, underpinning stock prices. But recovery also could mean a sharp rise in Japanese interest rates, which have been held to the lowest levels in the world in recent years as the Bank of Japan sought to avert an economic meltdown in the wake of the collapse of the country’s real estate and stock values.
Perhaps most important, a turnaround in the Japanese economy should begin to restore the shattered confidence of the country’s consumers and investors. The latter remain incredibly suspicious about stocks, and for good reason: Japan’s Nikkei-225 stock index, at 22,332.40 on Tuesday, still is down a spectacular 43% from its 1989 peak.
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Yet so far this year the Japanese stock market has continued to reflect an economic revival. Through Tuesday, the Nikkei index was up 12.4% year-to-date, better than the 10.5% gain in the Dow Jones industrials. And the Nikkei is up a dramatic 54% since June 30 of last year.
One U.S.-based bull on Japanese stocks is Bill Wilby, manager of the $3-billion Oppenheimer Global stock mutual fund in New York. He has 14% of the fund’s assets in Japanese issues, including such names as electronic games company Nintendo, entertainment giant Sony and convenience store chain Family Mart.
Wilby expects that the combination of corporate cutbacks and the depreciation of the yen over the past year will mean earnings gains of 50% to 100% for many Japanese firms in 1996 over 1995. “I think earnings are very underestimated given the leverage [many firms] have in Japan,” Wilby says.
Jamie Rosenwald, whose Rosenwald Capital Management in Redondo Beach manages about $400 million, owns stock in such export-oriented companies as Sony, Canon and conglomerate Matsushita Electric, and expects them to continue to do “very, very nicely” if the economy accelerates and the yen remains weak. Sony’s U.S.-traded shares have risen 43% over the past year, to $65.25 now on the New York Stock Exchange.
From U.S. investors’ point of view, the yen’s trend is key. The yen’s devaluation from 80 to the dollar a year ago to nearly 108 currently has helped restore some lost competitiveness to Japanese exporters. But that devaluation also has depressed U.S. investors’ returns in the Japanese market, because capital gains there buy fewer dollars when repatriated here.
Hence, while the Nikkei is up 12.4% this year, most U.S.-based mutual funds that exclusively buy Japanese stocks are up less than 4%, after rising 9%, on average, in the third quarter of 1995 and 4% in the fourth quarter. Even funds that try to hedge their currency exposure haven’t been able to protect themselves entirely this year.
Rosenwald says the best scenario going forward is for the yen to continue depreciating versus the dollar, but slowly--so that the boost for Japanese exporters’ stocks more than offsets the devaluation penalty for U.S. owners of the stocks.
But that scenario may well depend on what happens with Japanese interest rates. If the Bank of Japan feels compelled to raise rates now that the economy appears to be on more solid ground, the yen could begin to strengthen again--which could be devastating for exporters’ stocks.
Even domestic-oriented Japanese stocks obviously could be depressed by higher rates. Japanese stocks remain among the world’s most expensive as measured by price-to-earnings ratios, although some analysts say that measuring stock prices relative to corporate cash flow puts the Japanese market about on par with the U.S. market.
For now, many pros think the Bank of Japan will be patient. The Japanese financial system, reeling under heavy bank loan losses, “still isn’t strong enough to sustain any big interest-rate hikes,” argues Sharish Malekar, international bond manager at Strong Funds in Milwaukee.
Higher Japanese rates also could put further upward pressure on already-rising U.S. rates.
Ironically, though, higher interest rates may be exactly what is needed to push more Japanese back into their own stock market. Barton Biggs, investment strategist at Morgan Stanley & Co. in New York, points out that the average Japanese institutional investment portfolio is 70% bonds, 30% stocks. “Local Japanese sentiment about equities is still unbelievably depressed,” Biggs says.
But if rates should begin to rise, making bonds a sure losing bet, the Japanese may be forced to regard their stock market as U.S. investors now regard the U.S. market: the only game in town.
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Still Struggling
U.S.-based mutual funds that invest specifically in Japanese stocks have mostly lagged Japan’s Nikkei-225 stock index this year, mainly because of the depressing effect of the falling yen. A sampling of fund performance:
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Total return: 5 years 1996 Fund to 3/31 to date DFA Japan Small Co. +2.7% +8.7% Warburg P. Japan OTC NA +4.7% Japan Fund -1.1% +3.1% Fidelity Japan Small Co. NA +2.8% Fidelity Japan NA +2.6% T. Rowe Price Japan NA +2.5% Franklin/Templeton Japan NA +2.2% GT Global Japan A -0.6% +1.0% Nikkei-225 stock index* -15.1% +12.4% Avg. U.S. growth fund +90.1% +7.3%
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* in yen terms, not including dividends
NA: not available (fund didn’t exist for entire period)
Source: Lipper Analytical Services Inc.
