Japan, that most inscrutable of Asian markets, has again flattered to deceive. After a startling performance beginning in late 2005 when the Topix rose 40% in just six months after Junichiro Koizumi’s September election victory, the market has relinquished all of its gains.
Foreign investors that raced into the market in late 2006 in the hope of catching a sustained rally have been bitterly disappointed. Japanese investors remain unfalteringly depressed and have moved on to foreign markets. New prime minister Shinzo Abe has proved to be alarmingly accident-prone and the recent proxy round of company meetings has shown an alarming penchant in Japanese boardrooms for regressive governance.
It all paints a desperately gloomy picture. Yet despite appearances, now might prove to be the right time to invest in Japan’s equity market. According to Peter Tasker, an equity strategist at Dresdner Kleinwort, Japan’s benchmark index, Topix, is approaching what he terms the "concrete coffin lid", a resistance level of 1,750 to 1,800 – it sat at 1,765 at the time of writing – that has proved to be a key resistance level for all equity rallies since Japan’s market crash in 1989.
Tasker argues that Japan’s equity market doesn’t so much follow domestic factors as global ones and is highly sensitive to OECD leading indicators. When global growth trends have bottomed out and appear to be recovering, as is the case now, Japan’s equity market tends to outperform. And Japan’s sensitivity to global growth is only likely to increase in the future, argues Tasker. He estimates that overseas revenues for Japan’s 100 largest companies have doubled since 1999 and now account for some 40% of total revenues.
"Sustained underperformance, lowered expectations, solid corporate fundamentals and a benign global environment – this is a promising backdrop to Topix’s coffin lid challenge," he claims.
There is anecdotal evidence to support this thesis. Company profits have already grown strongly and look set to expand further. Corporate restructuring in Japan is a thing of the past and, despite appearances, M&A is no longer the filthy foreign idea it once was but rather has become a legitimate corporate activity.
What is seriously lacking of course is confidence among consumers and domestic investors alike. That might come soon. Japan’s companies will be unable to hold wages down for much longer in the face of rapidly improving corporate fortunes. Rising wages will fuel consumer activity and in turn increase optimism among local investors. And underlying the headline-grabbing recalcitrance of Japanese boardrooms to aggressive foreign activism is a fundamental, if gradual, philosophy shift towards acknowledging the need to boost returns to shareholders, a shift that is also being pushed by investors facing alarming demographic trends in chronic need of higher returns.
Now is a good time for investors to take a long hard look at Japan’s equity market. Like everything to do with Japan, none of this will happen overnight and investors will need to be patient. But when it does happen, Japan’s Topix coffin lid will be lifted quickly.