CHUCK LAMBERT, JF TOKYO, (813) 3503-7690
Japanese Market Outlook, November 1998
Recidivism in the LDP
The LDP is falling back into its old habits of backtracking on policies that should be good for Japan. Last week it decided
to postpone the debate on tax cuts until the next regular Diet session in January rather than try to pass them in the
extraordinary session which is expected to begin on Nov 27th. Although Mr Nonaka claims that there is not enough time
to work out the details before the extraordinary session, the press points out that the LDP has been wasting time, since it
did nothing to convene meetings of the Government Tax Comission between Aug 4th (when Mr Miyazawa proposed tax
cuts) and late October. The main problem seems to be that the LDP has not yet reached consensus with enough
opposition parties regarding the details, and is afraid of seeing its proposals shot down. Because of the delay, the press,
the Keidanren and even the Government Tax Commission itself are accusing the LDP of lacking a sense of crisis about
the economy. The delay is also one of the main reasons that the stock market fell last Thursday and Friday. The
weekend press reportts that the LDP is also about ready to adopt a modified version of the Komeito’s shopping coupon
plan and that support is building within the party for a temporary cut in the consumption tax. Whereas the Komeito
proposed issuing Y30,000 worth of shopping coupons to all residents, the LDP is proposing to issue Y20,000 worth of
coupons only to those under 15 and over 65. A two-year cut in the consumption tax, to 3%, has been proposed by Mr
Ozawa’s Liberal Party, and Mr Obuchi was encouraged by former PM Nakasone to support such a cut at a ryotei dinner
on Saturday night.
Resistance in the TSE
TOPIX moved above its 13-week m.a. last week, but was stopped cold as soon as it hit its 75-day m.a. line on Thursday
morning. It closed last week 11.1% above its Oct 15th low, and still has the potential to achieve a 20% gain from its low,
and thus become the seventh 20% rally since 1990. However, that is not a very challenging target, as it implies a TOPIX
level of 1,176--just below the low of Apr 98 (1,183.90) and well below the Jul 16th high (1,280.73). Last week’s 5.2%
recovery was led by financials (following the DKB + Fuji + YTB tie-up) and exporters (following the strong recovery on Wall
Street), and was supported by a 50% WoW gain in average daily volume, to 492.5 mn shs. Nine of the ten most active
issues were financial shares (the other was Nippon Steel), reflecting the more positive stance on Japan expressed by
Barton Biggs, James Cramer (Thestreet.com) and Robert Zielinski (Wall Street Journal). Foreigners appeared to have
been net buyers last week, with new money ooming in from the three main continents.
Bank rally continues
The TSE Bank Index outran TOPIX by 2.4% last week, to bring its outperformance since the Oct 2nd bottom to 19.9%.
Thus, the excitement about the DKB/Fuji tie-up more than offset the bad news from the interbank markets, where the
Japan premium has risen to as high as 106 bp for Sumitomo Trust Bank and where foreign banks are picking up TBs for
negative interest rates. Walter Altherr estimates that the new DKF Trust Bank may add as much as Y3 to the EPS of DKB
and Fuji in optimum circumstances, and he observes that YTB is selling its best business in exchange for funds to help
clean up its balance sheet. By the end of the week, DKB and Fuji had decided that they would pay only Y140 bn for YTB’s
custody business and Y4.6 tr in pension assets under management, rather than Y150-200 bn for 80% of those
businesses. The implication is that the trust banks’ pension businesses are not as valuable as many analysts had
assumed. Although new foreign money has been coming into bank shares, domestic holders continue to unwind cross
holdings and sell into any strength. Technically, the bank shares still have the potential to move higher, as they have held
up well since the massive surge in volume in the week ended Oct 23rd. Stocks which have cleared their Oct 22nd highs
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CHUCK LAMBERT, JF TOKYO,
(813) 3503-7690
include BOTM, Fuji, Sumitomo, Daiwa, Mitsui TB, YTB and Toyo TB; stocks which have moved above their 13-wk and 26wk m.a. include NCB, DKB, Sakura, Fuji, Sumitomo, Daiwa and YTB.
Earnings disaster
With 21% of companies reporting, aggregate OP fell 43.9% on a 7.6% decline in sales in the 1H. Those companies are
optimistically projecting that full year OP will decline ‘only’ 30.4% on a 5.2% decline in sales, implying a 2H recovery
engineered by the economic package to be announced on Nov 16th.
GDP down
JF’s Chris Calderwood has just revised down his GDP forecasts to -2.4% for FY98 (from -1.8%) and to -0.3% for FY99
(from +1.0%), based on the poor data released for recent months and a cutback in expectations for the economic
package. In his words, “income tax cuts, public works and cheap public lending are not the way to turn this economy
around.” Indeed, JF Strategist Giles Ockenden has long argued that a cut in income taxes from their already low levels
would do little to enervate the economy; without a pickup in confidence, most of the money will be saved. (Cuts in
corporate taxes and housing taxes, however, would be much more likely to have positive effects). The steel companies
report that domestic demand is picking up slightly from the bridge industry (suggesting that last spring’s Y16 package is
starting to come through), but that is nowhere nearly enough to offset the slump in demand from housing and autos.
Although the Economic Strategy Council and the Keidanren are keeping up the demands for 21st century public works
(such as urban development and information infrastructure), it is risky to assume that the LDP will deliver the goods.
Cheap public lending may offer nothing more than the transfer of loans from the private banks to the public ones. Already,
the BOJ has become a major buyer of CP. Meanwhile, the banks are taking advantage of the new Y20 tr loan-guarantee
program that was set up to encourage lending to small and medium firms; instead of lending to new customers who qualify
for the guarantee, they are forcing their existing customers to apply for the guarantees when existing loans are rolled over.
The sacred cow
Weekly magazines have reported that although bankers are calling in loans wherever they can, the LDP is interceding on
behalf of construction and real-estate firms to ensure that their loans are rolled over. Thus the brunt of the credit crunch
must be borne by manufacturers, retailers and service companies. In fact, the data support these types of anecdotes.
BOJ figures quoted in this week’s Ekonomisto show that in the Apr-Jun quarter, banks loans to large construction, real
estate and finance firms rose 10.6% YoY whereas those to small and medium firms as a whole slumped 2.2% YoY. The
banks are robbing the companies which should provide future growth to support those which are still trying to wind down
from excessive expansion during the bubble. Meanwhile, EPA Director Sakaiya pointed out on NHK that Japan is the only
developed country in the 1990s to have more companies going out of business than new companies being established.
Another sign that Japan is dying.
Exporters surge
Export shares have staged a strong recovery, taking their cue from the recovery of Wall Street and the mild gains in the
dollar. Canon led the way, though volume was light and resistance was met at the 13-wk m.a. of Y2,663. In yesterday’s
Nikkei Financial Daily, President Mitarai said that the shares are too cheap and that Canon is always trying to restructure
to enhance shareholder value. For example, the TS1/2 program aims to cut production time and space in half, so that
production can be expanded without building a new plant. To counter criticism that the oompany does not have any new
core products, it is developing new products for multi-media, such as wall-hanging TV and portable information terminals,
and it aims to take top market share in digital cameras. He does admit, though, that the sudden gains in the yen will make
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CHUCK LAMBERT, JF TOKYO,
(813) 3503-7690
FY98’s profit targets hard to achieve. Aiwa told JF’s Fujino-san that the full Y1 bn cost for the recall of mini-compo units in
the US was taken within COGS in 1H, thus explaining why OP was flat when sales rose 17%. If Mr Greenspan is correct in
his assessment that a credit crunch and a recession can be avoided, then Aiwa ‘s business climate should be much better
than expected and the stock is cheap on 23X PER. Technically, only a few exporters are above their major m.a. lines:
Toshiba, NIDEC, MCI, Hoshiden, Advantest, MEW, Nikon, Hoya, Tokyo Electron and Suzuki Motor.
This firm and its affiliates may act upon or use information contained in this report before it has been been published to the firm’s
customers. This information has been compiled from sources we believe to be reliable, but we do not hold ourselves responsible for its
completeness or accuracy. It is not an offer to sell or a solicitation to buy any securities. This firm and its affiliates and their officers and
employes may or may not have a position in or with respect to the securities mentioned herein. This firm and its affiliates may from time to
time have a consulting relationship with a company being reported upon. All opinions and estimates included in this report constitute our
judgement as of this date and are subject to change without notice.
_____________
Market Outlook, Nov 24-27
Market welcomes Ozawa
Last week the market overcame several hurdles (lousy earnings reports, disappointment about the Y24 tr package, the
Moody’s downgrade, the news that MOF plans for bond investors to take on at least Y10 tr of the Y12.5 tr in newly offered
JGBs, etc) to post a solid gain of 3.4%, boosting TOPIX to its highest close in 13 weeks. With TOPIX up 15.4% from the
Oct 15th low, investors may thank the various forces which appear to be bringing Ozawa Ichiro back into power. Many of
the market’s problems have had a political origin: the inability of political forces to resolve the LTCB problem and to pass
the various financial bills in a swift and resolute manner kept the market in a funk all through summer and left Japan
teetering with a steadily weakening banking system. The slump in the TSE to 12-year lows ravaged the value of cross
holdings and took a deep bite out of corporate earnings which were already pummeled by the weak economy. In
retrospect, it is interesting that the market bottomed about the time that the LDP started cooperating with the Liberals to
pass the second group of financial bills, ie the Financial Revitalization Bills, on Oct 16th. The instability of minority rule
became a deep concern for senior LDP leaders like Takeshita and Nakasone, and former Transport Minister Kamei
played a key role in persuading Cabinet Secretary Nonaka to rebuild relations with Ozawa. This set the stage for the
shocking agreement reached by Obuchi and Ozawa last Thursday night to work towards setting up a coalition by the start
of the next regular Diet session in January, and it was this agreement which fueled a Y2 rise in yen/dollar and a 2.4% rise
in the stock market on Friday. Despite the fact the Ozawa is very unpopular among Japanese voters, the market likes his
party’s proposals for a reform in the consumption tax, an overall tax cut of Y10 tr in FY99 (vs the Y6-7 tr in the package)
and cuts in the size of government. As always, however, the political situation is still fraught with uncertainty. Over the
weekend, Ozawa said in TV interviews that the coalition will not be achieved unless the number of cabinet posts is cut
from 20 to 17 and the consumption taxes are indeed radically reformed. In other words, he has issued an ultimatum,
which will make an alliance (not to mention a coalition) even more anathema to many in the LDP, but particularly those
with their own ambitions such as Yamazaki and Kato of the YKK trio. The proposal to chop three cabinet positions is quite
unpalatable to a lot of LDP members, and some in the Miyazawa faction say that any cabinet posts given to the Liberals
should come out of the Obuchi faction’s allotment, since it was their boss who did this deal with the devil. That is ironic,
because the scuttlebutt is that a man from the Liberal Party (ie, Mr Noda) will replace their own boss as finance minister.
In fact, it was the view that Mr Noda will be coming in that allowed the yen and the stock market to continue rising even
after Mr Miyazawa said at noon last Friday that there would be no tax cuts beyond those designated in the new package.
Technical vs fundamentals
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CHUCK LAMBERT, JF TOKYO,
(813) 3503-7690
Technical readings continue to improve, particularly since the Ten Vertical Reversal chart for TOPIX has just turned
positive, telling Japanese chartists that the long-term trend has reversed direction. This chart has the reputation of hardly
ever giving a false signal, but in fact that last two positive turns have been false: the one in Jun 96 led to a further gain in
TOPIX of a mere 0.19%; that in Jun 97 led to a further gain of only 2.77%. One reason is that Japanese fund managers
today are likely to know more about the Dupont model than about the charting methods handed down from the rice-futures
markets of the 1650s, and this was certainly illustrated by the detailed four- and five-part questions that were hurled at
Micron Technology’s spokesman at the presentation sponsored by JF last week. In fact, it is just this deep attention to
fundamentals that keeps institutional investors cautious in this current rally. It appears that overseas investors are much
more willing to bet that things are turning around, as they have been net buyers of Y405 bn in the five weeks since the
financial bills passed. Meanwhile, semi-pro individuals are shifting money from overseas bonds funds to low-priced
stocks, since the combination of BOJ injections and debt forgiveness for constructions seems to have sharply curtailed
bankruptcy risk, at least for listed companies.
Winners and losers
The strongest subsectors last week were DDI +10.2% vs TOPIX, Bridges +9.5%, Blue-Chip Components +7.4%,
Superstores +7.0%, Ito-Yokado +6.6%, Hitachi/Toshiba +5.7%, Autos +5.1%, General Contractors +4.0%, Roads +3.4%,
Secom +3.4%, Real Estate +3.4% and Discounters +3.2%; the weakest subsectors were Game Machines -8.8% vs
TOPIX, Rohm -7.0%, SPE -5.4%, Canon -5.1%, Kyocera -5.1%, Plant Engineers -4.4%, Nichiei -4.3%, Condos -4.3%,
Mining -4.2%, Tires -3.9% and EP -3.2%. The new relative highs wereIC Chemicals, Marui and Ito-Yokado; the new
relative lows Downstream Chemicals and Condos.
Dualism in exporters
One sign that the Tokyo market is becoming more mature (more fundamental) is the discrepancy in the performance of
electrical stocks last week. Traditionally, they all outperform or they all underperform, or else investors go for high-priced
ones rather than low-priced ones, or vice versa. But last week brought double-digit gains in Murata, TDK and Hirose but
declines in Kyocera and Rohm. Investors seemed impressed that Murata had recovered the lead that it had lost in
capacitors, but disappointed by the deterioration in OP margins at Rohm. Similarly, both Toshiba and Omron posted
double-digit gains on signs of progress in their restructuring efforts, while Shinko and Ibiden fell on news that Intel will be
taking a much harder look at packaging costs, as mentioned in Steve Myers’ Intel note. In the auto sector, Nissan +14.4%
and MMC +15.5% surged on improved volume (especially in MMC, which doubled the previous week’s already high
volume) while Honda +11.1% continued to get milage out of its record earnings report. With auto stocks also on a tear in
the US, investors seem to believe in a continuation of strong US demand. Meanwhile, Yamaha Motor slumped 8.5% on its
downward revision while Mazda merely matched the market as its high US inventory becomes a worry. Toyota, whose 1H
OP rose only 1% despite an 11% rise in sales, should see its share price weaken except that 1) it surprised investors by
not joining other Mitsui companies (yet) in subscribing to new Sakura shares and 2) it is held in such awe by otherwise
fundamental domestic investors.
Alice in Bankerland
The nine city banks have now announced 1H earnings, but before you start going over their financial statements, be
forewarned that they are using four different standards for disclosing risk assets. They also continue to use the easier
accounting standards allowed from last fiscal year, so pretend that they don’t have any unrealized losses on the stock
portfolios and that their financial statements mean exactly what they want them to mean, ie, that they are all heathy banks
with wholesome equity ratios in excess of 8%. Eight of the banks (excluding BOTM) plan to apply for Y4 tr in public money
in order to boost their ratios above 10%. Most banks aim to boost reserves for Category II loans to 15% (from 2-5% now),
but Sumitomo uses strict definitions for three grades of those loans whereas Fuji and Sakura are using loose definitions
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CHUCK LAMBERT, JF TOKYO,
(813) 3503-7690
which allow them to get by with several tens of billions in lower reserves. Also, if the banks were required to mark their
stock portfolios to market, then Daiwa Bank’s Y380 bn net loss on its portfolio would reduce its equity ratio from 9.8% to
4.9%. Altogether, the city banks plan to write off Y5.08 tr in bad loans in FY98, and post a net loss of Y1.32 tr rather than
the initial forecast for a net profit of Y580 bn.
Bank lending in Q3
Last week’s BOJ bank lending data for the September quarter revealed some interesting points. The outstanding balance
of bank loans fell 0.8% to Y495.6 tr. Loans to corporations fell 1.9% YoY to Y386.7 tr (ie, 78% of the total), those to
individuals rose 2.2% to Y93.3 tr (18.8%) and those to public bodies rose 17.4% to Y8.5 tr (1.7%). Thus, although total
debt of the corporate sector may exceed the GDP figure of Y500 tr, their bank debt is “only” 77% of GDP--still above the
US level of 30-35%, but not as bad as we thought. Loans to manufacturers fell 0.7% to Y66.9 tr while those to non-mfg fell
2.1% to Y320.0 tr. Not surprisingly, nonmfg accounts for 82.8% of Japan’s corporate bank debt. By size of non-mfging
industry borrowers, bank loans fell 3.2% to Y73.9 tr at wholesalers, retailers and restaurants, fell 2.7% to Y73.5 tr at
services, rose 1.7% to Y65.1 tr at real estate, fell 6.1% to Y46.8 tr at nonbanks and insurance, fell 0.7% to Y30.1 tr at
constructions, rose 4.2% to transport and telecoms, and fell 13.3% to Y6.35 tr at EP/Gas. The data confirms anecdotes
that banks continue to increase loans to real estates and nonbanks, but not to construction. The data also show that small
companies may be having more loans called than big companies: loans fell 4.0% to Y244.0 tr (63.1% of corporate total) to
small firms, fell 0.2% to Y46.9 tr (12.1%) at medium firms and rose 3.0% to Y95.8 tr (24.8%) at big firms.
Tokuseirei
Loans to construction firms will fall in 2H, not because they are being called in, but because they are being forgiven. The
Y700 bn in debt forgiveness announced last week for Fujita, Haseko and Aoki amounts to 2.3% of the bank loans to the
construction industry. Curiously, the major general contractors outperformed by 4% last week even though their mid-sized
rivals are being kept in business with significantly reduced debt loads.
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