This September the IMF forecast that the Japanese economy would grow by 2% this year and by as much again in 2006, which would make 2003-06 the country's best period of growth since the economy began stagnating in 1990.
Foreign investors have also started to pay attention. Japan equity funds have attracted a net $1.5 billion in inflows since the end of July, according to Emerging Portfolio Funds Research, a fund flows tracker. Data from State Street also show near record inflows.
But perhaps the best example of the new strength of conviction was Nomura's London roadshow this September, the first it has held for Japanese equities in 15 years.
Nomura highlights the fact that Japanese companies are now showing their fourth or fifth year of profit growth and argues that corporate earnings growth is sustainable.
Corporate governance improvements are a key driver of many of the positive trends in corporate Japan. Japanese companies, argues Nomura, have become more shareholder friendly than before, dramatically increasing their total returns to shareholders in recent years, through increased dividends as well as share buybacks. They have also become more prudent in their capital expenditure plans. Capex has been on the increase since 2003. However, unlike in previous times of earnings expansion, tangible fixed asset expansion has been curtailed, resulting in improved operating margins.
At the same time, management teams are using their strong cashflows to go on the offensive. In the first half of 2005, the number of large M&A deals (those exceeding ¥10 trillion in value), reached 130, the highest figure on record on an annualized basis.
Japanese companies are also benefiting from the strength of their overseas businesses, which are showing record high recurring margins. Overseas sales are becoming even more important to Japanese companies. Overseas sales accounted for 16.1% of total sales for Japanese manufacturers in financial year 2004, compared with just 5.6% in financial year 1991.
The Japanese equity market is also expected to benefit from an end to the domestic structural selling that had been one of the reasons for the prolonged slump in the Japanese stock market. Japanese businesses have for years been busy selling large blocks of shares to unwind their dense webs of cross-shareholdings, but Nomura believes that this has now run its course. The ratio of shares held by investors with stable shareholdings, banks and insurers, versus those held by pure investors, such as individuals, pension funds, and foreign institutions, has changed from 67.4% and 32.3% to 37.9% and 62.1%.
Crucially, Japanese retail investors are beginning to show a bigger appetite for domestic stocks, shifting money out of deposit accounts into investment trusts and dividend funds. The average dividend yield of Japan's top corporations, at 1.3%, is now about the same as the yield on 10-year government bonds, and is proving attractive to retail investors who have been hurt by low interest rates.
Retail demand for equities has also been spurred by regulatory change. Since banks were first allowed to sell investment trusts in 1998, the net assets under management of their investment trusts have soared to ¥16 trillion. They now account for 50% of all equity investment trust sales. The availability of retail investment trusts is set to expand further next month, when the post office begins offering them through its retail branches.
Financial institutions too have started to increase their exposure to equities. Equities currently account for just 3% of the total assets held at banks, lower than the level before Japan's bubble era, while bond now account for 19.4% of assets. Aware of the risk of rising interest rates, more Japanese financial institutions could start allocating more funds to equities.
| ROE and recurring margin for Nomura 400 (excluding financials) |
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