The fiscal reforms implemented by the Japanese government in the wake of last year's economic turmoil in Asia have yet to show definitive signs of creating a lasting rebound in the Japanese equities market. However, there are indications that the groundwork is in place for the economy to be on a slow but steady road to recovery - although crisis is no longer looming, it is too early to expect a real upwards change.
Some observers question whether sufficient infrastructural change has occurred, or will be implemented, there have been a number of changes that will undoubtedly have positive long-term effects. In particular, the consolidation in the banking sector that took place late last year represents a much needed reform. Over-capacity in the financial services sector was a major infrastructural problem for the Japanese economy.
The consolidation in the banking sector is definitely positive," says Koichi Ogawa, chief portfolio manager at Daiwa in Tokyo. " In addition, companies have started their so-called restructuring, withdrawing from unprofitable business lines and focusing hard on profitability." Although he warns that these moves would be likely to cause deflationary pressure in the short term, he points out that it is clear that "structural changes are more important than cyclical recovery". In the longer term, these moves will have a positive effect on equities.
Ogawa sees a seachange in the Japanese government's attitude toward the economy and financial regulation. "The monetary authority has completely changed its style. By now, the government has done almost everything it has to do, but there is a limit. The budget deficit is becoming a problem - the government cannot continue spending to boost demand."
He warns that domestically the hard times are only just beginning.
For example, rising unemployment, previously virtually unheard of in Japan, is a real bitter pill for the Japanese people. However, it is also a positive sign, because it means that overcapacity is experiencing a much-needed adjustment. This is one clear indication that real change is occurring in the Japanese economy, a signal that should be heeded by foreign investors.
Foreign investors are again taking a cautious look at the Japanese equities market. Many have been attracted back to the market for the sake of diversification away from New York and Europe, which particularly late last year were looking a little over-bought. In addition, having pulled out of the market when the crisis began, many institutions are underweight in Japanese equities. However, a long-term ap-proach is essential for success.
"Investors will have to be patient," says Ogawa. "It is too early to expect a strong rally." It is true that last year's market rallies in July and November were short lived, inspired by enthusiasm for economic reforms as well as a feeling that equities in other parts of the world were overvalued in comparison with Japan.
Ogawa makes some predictions for 1999. In his view, earnings will be bad in the first two quarters of this year as companies face facts and restructure their businesses. Difficult circumstances in the fourth quarter of 1998, including rising interest rates and the bottoming out of the bond market, will also take their toll. However, the second half of the year will be a period of opportunity for those investors who look beyond cyclical problems and pay more attention to the efforts by Japanese companies to improve shareholder value. The positive results of these efforts will begin to manifest themselves in 2000 and 2001.
The big story of the start of 1999 in Europe -the launch of the euro -has had very little effect on Japanese trading patterns, agree all observers. "Japanese companies with European operations are continuing to trade in US dollars," notes Anne Marie Main, head of Japanese equities at Hill Samuel in London. "On the whole, the euro has had very little impact."
There are a number of reasons for this. One is that many companies have been focusing their energy and resources on making the infrastructural changes de-manded by the domestic economic crisis. The appreciation of the yen in the third and fourth quarters last year also made investment in European equities an expensive prospect for Japanese institutions, discouraging investment. This difficulty was compounded by the fact that many large institutions experienced substantial losses on the fixed income side as bond yields plummeted.
In addition, as Main points out, most Japanese companies work on a March year end and are unlikely to make major asset allocation changes towards the end of the financial year.
"You might see new asset allocations in April," she says, "but it would be strange to see much change now." Stephanie Schwartz"

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