CHUCK LAMBERT, JF TOKYO,
(813) 3503-7690
Japanese Market Outlook, January 1999
Off to a poor start
The Tokyo market has gotten off to a poor start in 1999, with TOPIX falling 2.6% and numerous widely held international
stocks performing far worse than the overall market. Sony, for example, has declined for seven days in a row and is
19.7% below its recent recovery high of Y9,420 on Nov 27th. Bridgestone, which fell 10.5% last week on hefty volume of
almost 10 mn shs, is 24.6% below its Nov 27th recovery high. Japanese investors seem to be more worried than the
Americans about a slowdown in the US economy and a coming pricking of the bubble in US share prices, and are
therefore selling many export issues. The prospects for the exporters are aggravated by the surprising gains in the yen so
far this year. Nevertheless, there are pockets of strength to make decent investment returns possible.
Foreigners off to a slow start
Foreign investors were fairly quiet in the first week of trading, and may have been net sellers. Perhaps the strength of the
yen is forcing overseas investors to reconsider their investment strategies for Japan, and perhaps the start of the Euro has
been causing European investors to start the year slowly. It is interesting that foreigners were slight net buyers in the final
two weeks of 1998, when the market was hit by the sudden crash in the bond market. In fact, the only big seller in the last
two weeks of the year was dealers, whose Y223.5 bn in selling virtually matched the Y225.2 bn in net buying by investors
as a whole.
Positive changes
One of the major signs of positive changes so far this year is seen in the policy announced by the Financial Revitalization
Committee regarding the conditions under which banks will be invested with public money. According to Nikkei reports,
the banks will be divided into three groups by quality. The stronger banks will pay a lower dividend on the preferred shares
that they issue to the government, and will be left alone to carry on business as they like; the weaker banks will have to pay
a higher dividend and will be encouraged by the authorities to close down money-losing operations and, if they are still
very weak, seek merger partners. This represents a radical shift away from the convoy system of the post war period, and
investors should welcome the fact that the penalties are now likely to be bigger for failure than for success. Furthermore,
the recommendation that banks close down loss-making operations fits in with a new appreciation in Japan of the need to
pare down excess capacity.
Cutting overcapacity
The problems related to overcapacity are well known to investors in Japan, and the need for measures to support the
elimination of industry’s massive overcapacity has been addressed in Chris Calderwood’s quarterlies. However, it is only
since the beginning of this year that the overcapacity problem seems to have become evident to corporate managers and
domestic economists, and this increases the chances that something will be done about it. In a New Year’s interview,
Keidanren Chairman Imai (also Chairman of Nippon Steel) said that Japan could not continue to support 5-6 big players in
every industry, each with a surplus of capacity. Later in the week, Nippon Steel President Chihaya pointed out the
problem in the small-bar industry, where some 30 makers had capacity of 18-19 mn tons at a time when domestic demand
is ony 12-13 mn tons. He suggested that some disinterested third party might have to be called in to arbitrate how the
excess capacity can be reduced. In a New Year’s roundtable discussion on the 1999 economy sponsored by the Nihon
Keizai Shimbun, two economists (Prof Takenaka of the Economic Strategy Council and Mr Nakamae) suggested that 1999
would be the year when industry starts in earnest to cut back overcapacity. Separately, Mr Kasai of the Japan Economic
Research Center recommended tax benefits for M&A and accelerated depreciation periods as two ways to encourage
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CHUCK LAMBERT, JF TOKYO,
(813) 3503-7690
companies to scrap excess capacity. The removal of excess capacity throughout 1999 is unlikely to have any immediate
positive impact on earnings, and may even entail additional extraordinary losses, but it should get Japan on the road to an
industrial structure where a few companies with core competence in each product segment make an adequate return on
their investments while the marginal players move on to focus on their own areas of strength.
Beware of getting what you want
Although the apparently new recognition of the need to get rid of excess capacity is one of the conditions that investors
want to see before turning bullish on Japan, the initial impact will have some negative consequences for asset prices.
After all, the elimination of capacity means the reduction of assets, so as companies gradually close down unprofitable
factories and outlets, the supply of real estate will rise. The slimming of assets means that the unwinding of cross share
holdings is likely to continue to accelerate. Net selling of equities by corporations doubled in CY98 to Y1.2 trillion, yet there
are still 40-50% of the shares of first section companies tied up in cross holdings. This suggests that companies from the
old Japan (materials companies, trading companies, banks, etc) will continue to struggle with both difficult business
conditions and a constant supply of existing shares coming onto the market, thereby capping the potential for the popular
indices. For that reason, it is encouraging that some sectors of the new Japan (semiconductors, drugs, software, services,
OTC) are enjoying strong share-price gains.
Where the action is
As the previous paragraphs shows, the strength in the First Section last week was very narrow, focused as it was on
semiconductors, Softbank, drugs and a handful of theme stocks. Although market volumes were subdued, there were
significant volume breakouts is a few stocks. Advantest (3.4 mn shs) saw its busiest week since Feb 98 and Tokyo
Electron (4.9 mn shs) since Oct 97. Softbank, whose 8.1 mn shs in December were only slightly below the record volume
of Jul 98, posted a weekly record of 6.0 mn shs last week. Nikon was fairly active on 7.7 mn shs after the president said
that the stepper and camera businesses may be split into separate companies, and that there is a chance profits could hit
a new record in a few years. There was also active trading in Kaken (which is said to have two major drugs in the
pipeline), Toshiba Ceramics (whose Hi-wafers are expected to be used in the small DRAMs which Toshiba will start
making later this year), Toshiba Tec (which is the sole supplier of terminals for debit card systems to NTT Data) and
Benesse (whose defensive, domestic qualities are being discovered). Unicharm, Toppan Forms and Secom rose to new
all-time highs.
Rising yields take their toll
The bond market was firm most of last week, and got a boost from a well-received ten-tear auction. However, the longterm prime rate will be raised by 70 bp to 2.9%, and the bond futures suffered a massive sell-off on Friday following
rumors that Japan’s sovereign debt ratings would be cut. Real estates, housing and nonbanks suffered the biggest
damage on concern about rising rates. Many local economists do not seem too concerned about the recent rise in bond
yields, as they see a yield around 2% as suitable for Japan’s economic condition. In fact, the BOJ’s interest-rate model
says that the JGB yield should have averaged 2.7% in Q4 ‘98. Since corporate Japan is a net debtor, the hike in the longterm prime could cause aggregate RP to decline 8.6% in FY99, compared to -5.1% if the long-term prime were left at 2.2%
(according to Nikkei NEEDS). Thus, companies from the old Japan, which have too much capacity, too many employees
and too much debt, will have to carry out their restructurings with a higher interest burden.
OTC surging
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CHUCK LAMBERT, JF TOKYO,
(813) 3503-7690
Once again, the close correlation between JGB yields and OTC performance is holding true. The bond market crash
which began around Christmas seemed to only intensify interest in the OTC, which is up nine days in a row and which last
week traded its biggest volume in years. Japan’s OTC is recognized by value investors as the last bastion of bargain
stocks in the world. The OTC stocks generally do not have very big cross holdings, and the strongest stocks are from
industries with a future, such as medicine/health care, semiconductors, networking, software and retailing. Very cheap
stocks are still available in all of those areas except networking. For example, Create Medic on 8.3X, Tsuzuki Densan on
8.4X, Saison Info on 14.6X and Right On on 10X. Software and networking stocks should remain in favor ahead of the
start of OTC trading in Oracle Japan (4716) on Feb 5th. Yahoo Japan, which soared 41% last week to Y12.0 mn, is being
talked about as a Y20 mn stock, and that may seem conservative given some of Friday”s moves in the US (BCST +49%,
GCTY +34%, LCOS +28%, CMGI +18%, YHOO +7.4%, etc). In fact, demand for internet trading in the US is so hot that
Charles Schwab posted a record number of 34 mn hits last Monday, but that soared further to 55 mn hits on Thursday and
then became so intense that the system blew out for a while on Friday morning.
Local recommendations
The stocks most recommended by local brokers are NTT DoCoMo, Nippon Zeon, NHK Spring, Toshiba Tec, NTT Data,
Softbank, Sharp and Fujitsu.
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
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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.
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