Hurtling towards its fourth recession in 10 years, the Japanese economy is once again in a vulnerable state. And the terrorist attacks on the US on 11 September have dealt the fragile Japanese equities markets a hefty blow, say equity strategists.
Export levels have contracted, and this vital source of revenue for Japan’s blue chip companies will shrink still further if – as many expect – US consumer demand continues to deteriorate.
“The economic fundamentals are very unclear,” says Yukiko Kawamoto, head of equities at HSBC Asset Management in Tokyo. “The exporting side is weaker than the domestic economy, whereas three years ago in the last recession, exporting areas helped the whole economy… This time domestic sentiment is not that awful,” she says. But despite worrying signs in the sector, HSBC does not consider there is a financial crisis in Japan, she says.
Even before the terrorist assault on the US, the Japanese economy was heading rapidly towards recession, says Nick Reid, senior investment manager at Gartmore in Tokyo.
“Exports had collapsed on the back of the global economic slowdown, and this in turn had depressed private sector capital expenditure and knocked consumer sentiment,” he says.
Exacerbating matters still further, prime minister Junichiro Koizumi’s new reformist government had decided to curb public spending in an effort to rein in the rapid growth of national debt, says Reid.
But in the wake of the attacks on the World Trade Center and the Pentagon, economists have had to trim 0.3–0.4% off Japan’s growth figures for this fiscal year. The International Monetary Fund has forecast that Japan’s gross domestic product will contract by between 0.5% and 1% this year.
The Bank of Japan has taken action to shield the economy from a deepening recession. It has pumped more money into the system, and has cut its discount rate from 0.25% to 0.15% as part of a concerted effort with other G7 central banks to boost liquidity and global economic growth. It has also been active in the currency market, intervening to stem the rise of the Japanese currency by buying US dollars.
Despite these moves, there are concerns that the central bank is not doing enough. A recent warning from the Bank of Japan’s governor Masaru Hayami that loosening monetary policy could trigger hyperinflation indicates a gap between the bank’s view of the economy and that of the government and private sector economists. Many economists believe Japan is now suffering from unprecedented deflationary pressure.

Apart from the fall in export volumes, Reid says there has been another serious consequence of the US tragedy for the Japanese economy. This is the delay to Koizumi’s reform programmes.
“In the light of the terrorist attacks Koizumi’s government has been preoccupied in deciding an appropriate response to terrorism…,” he says. Before these events, the prime minister had published an outline of his reform plans, which included a promise to speed up bad loan write-offs by strengthening the operation of the state-run Resolution and Collection Corporation (RCC).
The RCC was set up to buy banks’ bad loans and rehabilitate bankrupted companies. But now most details of these measures have still to be announced and this delay has depressed sentiment within the equity market, says Reid.
However, the stockmarket has come down so far that to be bearish now is actually aggressive, says Kawamoto. Smaller companies in particular could be good buys.
“Earnings figures at blue chips such as Sony are terrible this year, and without seeing a bottoming out of these companies, there won’t be much energy in the stockmarket,” she says. “Large cap exporting companies are suffering, but smaller companies which are domestically orientated are doing quite well,” she adds.
Reid says equity valuations are currently at a historically low level and this should
provide support to the market. Also, restructuring and mergers and acquisitions activity is expected to accelerate further as the economy plunges into recession. Corporate bankruptcies are also likely to increase, and this will benefit investors in the long term, weeding out weaker companies with high levels of debt amassed during the economic bubble of the late 1980s.
“Survivors of the structural changes taking place in this difficult time should reap the benefit as they should become fitter, and with fewer competitors. As a result, in our portfolios we are focusing on companies that are building a stronger corporate structure through restructuring and M&A activity and are likely to emerge as the ultimate winners in each industry,” he says.
Though Kawamoto is optimistic that the current weak economic situation will turn around, forecasting a timetable is difficult. “It’s very hard to tell when we’ll see real progress, but it could happen tomorrow.”

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