The Tokyo stock market peaked January 1990 at a level of 39,000 on the Nikkei 225 Stock Index. It then began a long, jagged decline before reaching its nadir at around 7,600 in April 2003. From there, it rose fairly steadily to more than 12,000 before sliding back to more than 11,000, with the general weakness in world markets, just about 50% higher than its low.
With Japan's stock market still some 70% off its peak, it looks like a strong buy for value investors. But before we get to some specific Japanese investments, let's look at the currency issues and macroeconomic factors that have had an impact on Japanese markets.
The currency factor
In international investing, as well as the stock market itself, you have to look at currency. The Japanese yen, which was valued at 160 yen to the U.S. dollar at the Japanese stock market's zenith in 1990, appreciated steadily against the U.S. dollar until 1995, when it peaked at 80 yen to the U.S. dollar. (It sounds confusing, but lower numbers mean a more valuable yen). With the dollar's strength in the late '90s, the yen then dropped, bottoming out at around 133 yen to the U.S. dollar in early 2002. Now it has risen to 110 yen to the U.S. dollar, an increase of about 20% over two years, which can be added to Japanese stock returns if you're a dollar-based investor.
Japan's great strength is its export sector. The country runs a large balance of payments surplus, and in light of the U.S. deficit, the yen should be generally strong against the dollar. Still, investors should be aware that the Bank of Japan fights any sharp rise in the yen by buying U.S. Treasuries.
The economy
Unlike the U.S., Japan has suffered more than a decade of asset price deflation -- in stocks and real estate -- despite an easy-money policy that has lasted since the mid-1990s. All traces of overvaluation and an economic bubble have been washed out of the system. Of course, commentators warn continually of the possibility of deflation and of the debt overhang in the Japanese banking system, but just as at the top of a bubble all risks are ignored, so too near the trough of a downturn do all risks seem insuperable.
At this stage, the overhang of bad debts in the Japanese banking system is easily manageable. The bubble real estate loans of the late 1980s are now at least 14 years sour and, for the most part, have been written off long ago. Three of the top four banks reported profits in the year to March 2004. Today's bad debts relate to industrial and service-sector companies, such as the supermarket chain Daiei, that have run into difficulty because of overexpansion in the 1980s and a decade of stagnation thereafter. In such extreme circumstances, even sound companies will get into difficulty.
In the next five years, Japan will face the economics of an aging population -- the same problem the West expects to confront in the mid-2010s. By 2005, one-fifth of Japan's population will be 65 or older. Meanwhile, fertility has dropped to 1.3 children per woman, well below replacement level. Like most advanced societies, Japan has an actuarial problem in its social security system, with the labor force slipping by 0.7% per annum between now and 2025. However, Japan's problem is occurring a decade ahead of everybody else's schedule.
Fiscal deficit plagues the Japanese economy and is largely due to infrastructure spending schemes to prop up the ailing construction industry, attempts to lift Japan out of recession, and a prolonged economic downturn that has reduced revenues. At its peak in 2002, the Japanese fiscal deficit was 10% of gross domestic product (GDP); the country's public debt is now 140% of GDP.
However, in late March, stock analysts raised Japan's debt rating to AA+ -- only one notch below the AAA maximum. The Japanese budget for 2004 increased public spending by only 0.4% in nominal terms, far below the 3% to 4% likely increase in GDP for the year. Since the country's tax system has "bracket creep," which increases tax yields more than proportionately as incomes increase, the budget deficit will likely decline sharply and continue falling as long as the economic expansion persists.
The future looks bright :haihai:
The long-term future for Japan is beginning to emerge, and it is largely attractive:
ﾂｷ The economy will continue to expand at a moderate rate, and the stock market will continue to outperform the U.S. and most European markets, though it could decline if the U.S. market takes a sharp drop.
ﾂｷ The banking sector will continue to deal with its problems, helped by an increasingly solid capital base and the return of many of its marginal borrowers to soundness.
ﾂｷ The yen will tend to rise as the Bank of Japan slows its frantic purchases of U.S. Treasuries.
ﾂｷ Japan will manage its expanding aging population fairly easily as its society adjusts to seniors working later in life and younger people paying higher Social Security contributions.
ﾂｷ The extraordinary strength of the Japanese export sector will diminish, but the domestic economy, no longer handicapped by an appallingly expensive distribution system, will enjoy a sustained and well-earned boom, fueled by imports that become ever-cheaper in yen, yielding attractive returns to investors in domestic service industries.