Ten years after the Japanese stock market suffered its dramatic plunge, following a decade in which the Japanese economic model - with its corporate cross-shareholdings, scandal-ridden financial sector, and notorious convoy system which prevents well-managed companies from outperforming the bad - has been pilloried, Japanese equity markets are suddenly soaring.
On December 29 1989 the Nikkei 225, the main index, hit a record 38,916. In the 1980s, the Japanese economy had boomed as never before. By the end of the decade, the country was close to overtaking the United States as the IMF's largest bilateral aid donor. With the 1990s came collapse, and the index plummeted by more than 10,000 points in the first four months. The Nikkei has headed downwards through most of this decade, hitting 13,197 points in October 1998. Since then it has rallied, rising by more than 5,000 points in eight months to 18,532 in July this year and since holding at around 18,000.
Now the debate is whether this recovery, underpinned by an economy which is still the second largest in the world, is going to last and whether a deregulation process that has meant the end of the convoy system will continue.
Alexander Kinmont, equity strategist at Morgan Stanley in Tokyo suggests two main reasons for a continuing Japanese renaissance. The first is international and linked to a huge global asset re-allocation and the second is domestic and tied to corporate restructuring.
"Investors have started to reconsider Japan after the collapse of the other Asian economies and recent fears that the Fed [US Federal Reserve] could raise interest rates by one point to cool inflation," says Kinmont. The result is that a lot of money is being reallocated to Japan. Many Japanese funds are repatriating their money and US funds are likely to head for Japan should the situation persist.
"And the stock market has started feeling the benefits of a restructuring process that has involved some of the major Japanese corporations over the last year and a half," says Kinmont. Last year, corporations such as Nippon Telephone & Telegraph (NTT), Fujitsu and Sony began to rethink corporate strategies. They are placing greater emphasis on financial returns and costs, and have begun to reduce staffing levels, in a change of management style that has cut through all corporate levels and invaded the boardroom.
"The last 12 months have seen a record number of management changes," says Kinmont. "New bosses from outside the traditional establishment have been appointed and many boards which used to consist of 40 to 50 people now have been reduced to 10-12. And each director has a precise responsibility linked to a particular area of operation."
Such restructuring can have dramatic effect on a company's valuation. NTT's shares have risen by 50% this year, beating the upward trend within the Tokyo market by 15%.
But are investors becoming over-confident that US-style corporate restructuring will revitalize Japan? Some analysts remain unsure. "Japanese companies are aware that something has to be done to change towards a more Anglo-Saxon approach but there is still a problem of culture that goes beyond the mere economic sphere," says Chisato Haganuma, equities strategist at Nomura headquarters in Tokyo. "Our culture is based on teamwork and nobody is used to taking decisions and responsibility for the mistakes. That's why our big companies still have a problem of a lack of leadership."
The current revival in Japanese stocks, may have more to do with interest rate and currency policy - interest rates are low and the yen is strong. Trevor Greetham, global strategist at Merrill Lynch in London points out that Japan (as well as the US and Europe) does not have an export-led economy. Exports account for only 10% of Japan's GDP and a rally in the domestic economy stimulated by low interest rates has a much bigger impact than a rise in exports prompted by a weak currency.
Given this, says Greetham, the Bank of Japan should concentrate more on domestic issues rather than worry about the competitiveness of Japanese goods abroad. It should focus on increasing the inflation rate, currently around zero.
Greetham says: "The thing is it seems they haven't understood it yet. At the moment the Bank of Japan is doing the right thing but for the wrong reason. It is printing money to weaken the yen but not to foster inflation. That's the reason why I am still medium-term bullish. I would be long-term bullish if the Bank of Japan understood the point and fixed an inflation target."
Alicia Ogawa, head of equity research at Nikko Salomon Smith Barney in Tokyo, points to the rationalization within Japan's domestic borrowing system that could take place in the next few years to provide companies with more efficient sources of funding. It means the dismantling of Japanese banks' cross-shareholdings with major corporations which at present prevent banks from becoming fully independent and subject to true market discipline.
"Japan is on the brink of a financial revolution," says Ogawa. "The Japanese financial market is still very simple and unsophisticated. Banks are really backward, companies borrow mostly from banks and there is no financial service in this country. For example, Japan doesn't have a proper asset-backed securities market. That's why there is a great opportunity to create a domestic borrowing market on the US model over here."
Companies such as the domestic internet investment and media company Softbank, GE Capital - which has recently entered the Japanese market - and Nikko Salomon Smith Barney itself will be the standard-bearers of this credit revolution, which may also involve other foreign firms as well as smaller Japanese financial companies.
But if most analysts agree that the stock exchange could enjoy a period of prosperity in coming months, advice differs on the best stocks for international investors.
"I think the old rule to invest in companies that have a significant number of foreign shareholders is still valid," says Ogawa. Though she adds: "It is still difficult for foreign investors to understand the complicated world of the Japanese economy with all the cross-shareholding but if I have to recommend some stocks, I would suggest pharmaceuticals. Japan is a society that is getting old and pharmaceutical companies are preparing for the aging of the country."