Tokyo's stock market may now be happily anticipating a new government following the resignation of Prime Minister Morihiro Hosokawa, but many think gloomy economic and market news still lies ahead.
To some, the Japanese market already had become fatigued after its first-quarter sprint. During that period, the Japan component of the Morgan Stanley Capital International Europe Australasia Far East Index gained 16.1% in U.S. dollar terms, compared with the modest 3.1% rise in the overall index.
Expected ugly corporate earnings reports are due out for the fiscal year ended March 31. The numbers might give investors additional reason for retreat - although the overall economy is seen as modestly brightening.
Understandably, a number of investors are taking a breather. Said Rodney Smith, co-chief executive of Seligman Henderson Co., New York: "We do see economic recovery in the latter part of this year, and we've been edging back into the market. But chaotic political conditions are causing us now to pause and draw breath. Although we have more money earmarked for Japan, we're now holding fire until we see how the situation settles, what government is formed, consumers' behavior and (the pace of) further political and economic reforms."
Michael Perelstein, managing director-international investments at MacKay-Shields Financial, New York, foresees the possibility that the third quarter could be better for the market. He believes "Japanese equities have more to go in the medium-term."
But right now, the catchword is caution. "Over the next two to three months, company reports will still be disappointing since they'll reflect the past fiscal year," Mr. Perelstein said. The market Mr. Perelstein calls technically overbought "has to digest these earnings from the past," he said.
In the fourth quarter, MacKay-Shields took some profits in Southeast Asian markets and poured much of it into Japan. Since then, the firm has maintained about a 40% exposure to the Japanese market.
GE Investments, Stamford, Conn., also was among those that had taken some profits from last year's hot Southeast Asian markets and redirected them largely to Japan. "By the end of the fourth quarter, the Japanese market had come down a lot, and some of those stock were coming on our valuation screens," said Ralph Layman, executive vice president.
But after Japan's early 1994 gallop, the perceived window of opportunity began to close. Nonetheless, GE's international portfolio ended the first quarter with a 19.8% exposure to Japan, compared with 14.8% at year's end.
Among its buys, GE Investments took a new position in Suzuki Motor Corp. Ltd. and added to its holdings of Nippon Express. In the latter case, the transportation/trucking company should benefit as Japan further opens its markets to imported goods needing transportation, said Mr. Layman.
"For the next six months, we expect the Japanese market will continue to be a difficult place to find value if the market stays at this level and the currency doesn't weaken substantially," he said.
Curiously, many managers remain sharply underweighted in Japan, even though a number of analysts are cheering for the market. For example, in March the Frank Russell Co.'s universe of 35 international managers had an average 25% exposure to Japan, compared with the EAFE benchmark weighting of 44.2%, reports the Tacoma, Wash., consultant.
That substantial underweighting contrasts sharply with recommendations of some analysts. Baring Securities, London, recommends a whopping 47% exposure to Japan for global portfolios. Among other factors, the firm cites expectations that the Bank of Japan will be continuing to ease monetary policy. This year, Baring expects Tokyo's market to be the top performing of all developed countries' markets.
Last week, Salomon Brothers in London lifted to 35% its recommended weighting to Japan in global portfolios from 20%. The firm cited signs of economic improvement (expected 1.1% gross domestic product growth for the fiscal year ending March 1995); perceptions that Japanese stocks, excluding financials, are inexpensive in price/earnings terms and in terms of forecasted earnings growth; a belief that economic gains could induce Japanese investors (who have been shying away from the market) to switch from Japanese bonds to equities; and the resignation of Prime Minister Hosokawa that "may clarify the political situation and accelerate the political fusion process."
In February, Edinburgh Fund Managers, Edinburgh, Scotland, acted on its perceptions of a brightening picture in Japan. The firm increased the Japanese component of its portfolios to a near market weight position. "The most important thing in our minds about Japan has been the emerging signs of economic recovery," said David Currie, the firm's head of Japanese equities. Contributing to this are a combination of factors: corporate restructurings; the effects of low interest rates; and expectations of even further fiscal stimuli, including the July income tax cuts retroactive to January 1994.
Why aren't politics too worrisome? Because the market failed to collapse on news of the prime minister's resignation, "the market is saying that it expects economic recovery and that politics won't deter it," said Mr. Currie.
In fact, a new government could even prove economically beneficial. For example, conceivably, "the new prime minister may accede to the Clinton administration's wishes" on opening the economy further to foreign trade. In turn, that would help depreciate the yen and aid Japan's exporters, he points out.
Edinburgh Fund Managers particularly likes small-capitalization stocks in Japan - which should benefit from the expected economic pick-up.
Baillie Gifford & Co., Edinburgh, also likes some Japanese small caps, such as Ichiyoshi Securities, a second-line stock broker much involved with Japan's growing over-the-counter market. Still, Baillie Gifford hasn't been "joining the general enthusiasm ... for Japan," said fund manager Gerald Smith.
But Mr. Perelstein of MacKay-Shields suggests emphasizing the exporters - names like Sony Corp. and Hitachi Ltd. - whose earnings have been depressed by the artificially high yen.