Will Foreign Funds Create a Tidal Wave for U.S. Markets?

The corporate symbol emblazoned across the newspaper ad--a pyramid with a stylized sun rising behind it--would be immediately recognizable to many American investors. But in Japan the typical small investor is only now being introduced to the Fidelity Investments logo--and to Fidelity’s menu of mutual fund choices.

“A New Era of Investing Begins With Fidelity,” the ad proclaims. The timing of the campaign, launched last week, is no accident: The Japanese government’s long-awaited move to deregulate the country’s financial services industry began Wednesday. More than $9 trillion in Japanese savings is up for grabs, as the government removes barriers that have made it difficult or impossible for average Japanese to move their money outside Japan in search of better returns.

Major U.S. financial concerns, like Fidelity, are hungry for a piece of that extraordinary pie. Even a tiny slice of $9 trillion, after all, would constitute a virtual feast.

And for the U.S. stock market--which saw the Dow Jones industrial average cross 9,000 last Friday before slipping to close at 8,983.41--Japan’s financial services “Big Bang” may be happening at a very propitious moment.

The Japanese have earned an inglorious reputation over the last decade as inept investors. They appear to have mastered the fine art of buying high and selling low. “Basically, they are the peak buyer,” said one Los Angeles money manager who has been actively involved with Japanese investors for many years.

In love with their own stock market in the late 1980s, they pushed the Nikkei-225 stock index to a stratospheric 38,915 by December 1989. Now, eight years later, the Nikkei--at 15,517--is a shadow of its former self, and trying to interest Japanese investors in Japanese stocks is usually described as a laughable effort.

*

The Japanese also paid sky-high prices for U.S. “trophy” real estate properties in the late 1980s, including New York’s Rockefeller Center and California’s Pebble Beach golf resort. Although critics argued that America was in danger of becoming a Japanese plantation, the American sellers of those properties were smart enough to recognize that they were being offered absurdly high prices that might not come around again.

Domestic buyers have since picked up many of those properties from the beleaguered Japanese at fire-sale prices, although it’s also true that, so far, plenty of Japanese owners of U.S. real estate have chosen to keep their losses on paper rather than sell and realize them.

Even over the last year the Japanese were zigging when they should have been zagging. Between June and January they were net sellers of U.S. Treasury securities, as their holdings fell from $317 billion to $293 billion, according to Treasury figures.

The British and the Germans, meanwhile, were buying, raising their combined U.S. Treasury holdings from $305 billion to $390 billion in that period. It was a smart move: Foreign buyers of Treasuries have reaped handsome gains as U.S. yields have fallen and as the dollar has strengthened, boosting the value of dollar-denominated securities in foreign currencies.

Foreign sellers, by contrast, have left a lot of money on the table.

*

The Japanese haven’t cornered the market on bad investment moves, of course. (Donald Trump was still an American, last time we checked.) But Japanese buy-and-sell decisions, in the aggregate, have been notoriously wrong-headed for longer than most Japanese now care to remember.

Which brings us back to the Big Bang. Will the Japanese, suddenly offered the opportunity to invest with ease in the high-flying U.S. stock market, end up “buying high” once again--perhaps from American investors who, as with trophy real estate in the 1980s, figure that these prices may be a once-in-a-lifetime occurrence?

Whatever funds flow from Japan’s pathetically low-yielding savings accounts (where savers earn annualized yields of less than 1%), it’s almost sure to be modest at first. Shell-shocked by their own eight-year bear market in stocks, individual Japanese have good reason to be cautious.

Fidelity is offering Japanese just one U.S. stock fund to start--a blue-chip fund. Five other new Fidelity funds include two Japanese stock funds, a European fund and a U.S. high-yield fund.

Merrill Lynch & Co., which will open 33 offices across Japan this summer, expects its operations to be unprofitable for a couple of years as the business builds, a spokesman said.

*

For many Japanese, the most logical first step would be to move into a U.S. or global money market fund offering yields four to six times as high as Japanese bank savings accounts, albeit with the risk of foreign-exchange market swings.

(Money market funds were, in fact, the first mutual fund choice for many Americans in the late 1970s. That set the stage for the beginning of the buying surge in stock and bond funds in the 1980s.)

John Gernon, vice president of marketing for Fidelity Japan, said his firm also is seeking to change the mentality of the typical Japanese investor, for whom trading is a more natural mind-set than long-term investing.

Japanese investors’ average holding period for mutual funds is just six months, Gernon said, compared with several years in the United States. Much of the trading activity, he said, is encouraged by Japanese brokers who are, not surprisingly, sales-oriented.

Still, for Fidelity, Merrill Lynch and other U.S. financial giants, that $9 trillion-plus in Japanese savings is so massive a sum that to ignore the opportunity to manage some of it would seem a strategic blunder.

*

If the Japanese do begin to get hungry for U.S. stocks, they could have lots of company: Last year, foreigners’ net purchases of U.S. stocks rocketed to a record $66 billion, up from just $11.9 billion in 1996, government data show.

That wave of foreign investment flowing onto Wall Street was mostly European in origin. Britain-based buyers alone accounted for $22 billion of the $66 billion, although because the British are global money managers, the original sources of that $22 billion are difficult to trace.

Overall, Europe-based investors accounted for $59 billion of the $66 billion. Japanese investors accounted for a mere $4.8 billion.

If $66 billion doesn’t sound like a lot of money relative to the U.S. stock market’s $14-trillion market capitalization, that sum still gave foreigners the distinction of being the second-biggest buyers of U.S. stocks after domestic mutual funds, said David Strongin, who tracks foreign capital flows at the Securities Industry Assn. in New York.

The magnitude of the increase in demand, compared with previous years, also stunned many Wall Street veterans. “During 1990 to ‘96, European net purchases of U.S. stocks averaged $5.9 billion a year. So last year’s amount was 10 times greater,” noted Joseph Quinlan, a Morgan Stanley Dean Witter analyst in New York who watches capital flows.

European investors, Strongin said, were responding to the same positive fundamentals that were encouraging U.S. investors to raise their stakes in the stock market: low inflation, tame interest rates, strong corporate earnings growth and a disappearing federal budget deficit.

It has helped, too, that the dramatic changes sweeping Europe’s economies and companies, as monetary union approaches on Jan. 1, have been focusing European companies on boosting value for shareholders--which, in turn, has boosted European investors’ interest in owning more stocks, period.

German and French investors, Quinlan noted, “have long been averse to owning equities in general, let alone foreign equities.” Yet they were big buyers of U.S. stocks last year. “A shareholder mentality is building in both countries, and one of the early beneficiaries is perhaps the United States,” Quinlan said.

*

Certainly, the attraction of the U.S. market also was enhanced by the economic and market debacle in Asia, which caused global investors to shun those markets.

Whatever the reason, foreign buying of U.S. shares undoubtedly contributed to the 31% jump in the Standard & Poor’s 500-stock index last year, and probably has helped drive the 16% advance in the S&P; so far this year.

Wall Street’s bears point out that the last time foreigners were consistent, heavy net buyers of U.S. stocks was 1986-87--leading up to the market crash of October 1987.

It could well be that foreigners, once again, are late for the party. Then again, if the U.S. economy’s fundamentals remain so positive, foreigners’ stock purchases thus far could be the vanguard of a much bigger--and long-lasting--wave to come.

*

Tom Petruno can be reached at tom.petruno@latimes.com

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Give Us Your Millions, Your Billions . . .

Foreign investors’ net purchases of U.S. stocks rocketed last year, helping provide the fuel that sent the U.S. market soaring for a third straight year. Now, Japan’s “Big Bang” financial markets deregulation could bring more foreign money into U.S. securities. Net foreign transactions in U.S. stocks by foreigners each year, in billions of dollars:

1997: $66 billion

Source: Securities Industry Assn.; U.S. Treasury