By Scott McGlashan, manager of the Close Finsbury Japanese Equity Fund The Tokyo stock market fe...
By Scott McGlashan, manager of the Close Finsbury Japanese Equity Fund
The Tokyo stock market fell back last month in sympathy with the rest of the world's markets, erasing most of the gains achieved in the first six months of the year.
It is not time for investors to pull out of Japan. Recent losses provide a buying opportunity.
The economy is performing much better than expected. Indeed, Japan was the best performing economy among the G7 nations in the first quarter of the year and recovery is carrying on as a result of strong exports to the rest of Asia and a modest upturn in consumer expenditure.
A sharp upturn in corporate profits can be expected in the current year as a consequence of economic recovery, the benefits of corporate restructuring and the absence of enormous exceptional losses declared last year.
Valuations are also modest compared with historic averages and the values prevailing in other world markets.
There has been a fundamental improvement in the basic supply and demand for shares as a consequence of corporate share buybacks. In recent years, companies have been large net sellers of equities as they sought to unwind corporate cross-shareholdings built up over the previous 25 years.
The scale of share buybacks is such that much of this supply is being reabsorbed by the corporate sector itself rather than depressing the stock market.
Optimism for the market in the short term must be tempered by awareness of two related external risks: a collapse in the US dollar or a collapse in American share prices.
Dollar weakness, or yen strength, will aggravate deflationary pressures that have done so much to undermine corporate profitability in recent years.
For this reason, the reaction of the Bank of Japan will be to intervene on whatever scale is necessary to ensure the decline of the dollar against the yen is orderly.
Longer term, it is likely to result in inflation, which would cure many of the economy's structural problems, especially the never-ending bad debt situation of the banks because of weakening property prices.
A meltdown on Wall Street is likely to cause short-term panic in all of the world's equity markets. However, for Japan, this panic might only be short term.
Global equity markets are at an inflection point just as they were a little over a decade ago.
Then, in the wake of the bursting of the Japanese equity bubble of the 80s, capital flowed out of Japan and into the rest of the world's security markets, especially into Wall Street. Now, capital will flow from the States to the rest of the world's markets.
The contrast between the corporate sectors of Japan and America could hardly be greater. Japanese companies have been paying down debt for the past five years as they have been generating positive free cashflow.
In the months to come, investors will see that the much-maligned Japanese-style capitalism is not to be written off either. Its hidden economic strengths will emerge at a time when the new economy of Enron and WorldCom is consigned to the dustbin of history.
Japanese companies generating cashflow.
Valuations looking modest.
Economy performing better than expected.
Potential collapse in US share prices.
Market fallen back in line with others.
Bad debt situation in banking sector.