Will the Sun Ever Rise Again?        Mar.  2001 - Issue 7

  
Who would have thought that just over a decade ago, their stock and real estate markets were about to implode. Did we really listen to Fund Managers and strategists justifying valuations at 70 to 90 x earnings due to the benefits of Keiretsu, the Japanese system of cross-shareholdings between the banking community and corporates. I can even recall a couple of recommendations to increase weightings as, 'never mind 40,000, the Nikkei 225 index was likely to rise towards the 100,000 level'. Really, it never is different this time, is it?

Either way, here we are with the Nikkei at the 11800 level, a whole 11 years later. Yes, this Equity index has fallen by 70%, as has property and land prices from their peaks, wiping out many investors and businesses along the way. What can we learn from this and where is the future? Will the sun ever rise again?

The aforementioned chart shows shows the monthly closing price of the Nikkei since 1980 up until the 1st March this year. (Off the peg March 01 Nikkei 225).

After a promising rally from mid 1998 until April 2000 the Nikkei has plummeted a mighty 38% since. Subscribers to our Investmentimer service were alerted of the Sell signal on the 14th April 2000 by e-mail alert, when the index was at the 20435 level, since when the model has remained a Sell.

Policy makers had hoped that numerous supplementary budgets, including massive infrastructure spending would be sufficient to kick start the economy. Furthermore a near zero interest rate policy has failed to mobilize the huge Japanese private savings rate into consumption, an area that represents some 60% of the Japanese economy. Why should this be?

At it's simplest; we suggest it is to do with demographics. Japan has a greying population, probably the highest percentage of elderly people within its citizens in the major economies. Ageing of course brings with it risk aversion. You do not hit a greying population with a 70% fall on their equity and property investments and expect them to come rushing back for more. Compare this to the Asian crisis, which struck in 1997, where most of the markets had recouped most of the falls witnessed within a 2 to 3 year period. Perhaps this is related to the demographic profile of Asia ex Japan, where 60% of the population is aged under 25. If we think back to our younger days, risk rarely entered our equations. Perhaps there are lessons here to guide us to how the West is likely to respond to the current collapse within Western Equity markets.

Political and bureaucratic inertia has certainly not helped either. They have been extremely slow at introducing restructuring policies, not assisted by conflicting statements between the Bank of Japan and the Government. There has been a refusal to 'bite the bullet' in respect of the ailing banking sector, still riddled with massive debt.

Japan may however be approaching a turning point. Ten years on since the bubble collapse, cross holdings have fallen from 60% of market capitalisation to approximately 40% now, still a high figure. To date Japanese banks have been allowed to value the securities holdings at the book value i.e. the price at which they had invested. From April of this year they (and corporate's holdings of bank shares) will move to market to market accounting i.e. value at the market price. This is likely to accelerate the unwinding of the Keiretsu allowing an increase in take over activity by other domestic and foreign companies.

Furthermore, there is recognition by the politicians that the massive fiscal deficit is unsustainable. A policy of devaluation is likely to rob the high domestic savers to reduce the states debt. This is known as Tax by another route.

In conclusion, whilst in the shorter term, the accelerating sales of cross holding of equities and an increasing unemployment rate, due to corporate activity is likely to continue the pain, there is at least a light at the end of the tunnel.

Bear markets usually end when capitulation is complete. After the initial two year fall of the Nikkei from a near 40,000 level to about the 14,000 level, the index had spent the following eight years trading between 14,000 to 20,000. Of late the longer term support level of 12,800 has been penetrated to the downside, opening the possibility of a continued fall towards the psychologically important 10,000 level.

We are approaching the point of capitulation when even the most ardent Japanese investor, many of whom have remained invested throughout this long and painful period, are finally saying 'get me out'. History tells us that this is normally the birth of the next Bull market.

Subscribers to our services will be assisted in identifying when this point arrives. (Click here to subscribe on-line, or E-mail your request)