Institutional investors are betting that any U.S.-Japanese trade war will turn out to be little more than a spat.
The failure of trade talks between the two countries rattled the Japanese stock market and boosted the yen, but money managers think the conflict will be resolved quickly and that the Japanese economic recovery will remain on track.
Some investors appear to be waiting to see just what the Clinton administration will do: on Feb. 17, volume on the Tokyo Stock Exchange was down about one-third from average volume this year.
Meanwhile, the political posturing is strengthening the positions of President Clinton and Prime Minister Morihiro Hosokawa in their home countries.
Money managers said the failure of the trade talks has not altered their investment decisions, and is more of a blip on the horizon.
The collapse of the talks "must be a negative, but one that one must not exaggerate," said Piers Bertlin, assistant director, UBS International Investment Management, London. "A compromise must be reached eventually."
Politically, the failure of the talks actually could help Mr. Hosokawa, said David Warren, executive vice president of Rowe Price-Fleming International Inc., London. A threat of foreign pressure could motivate Japanese bureaucrats to yield to greater political and economic reforms, including removal of trade barriers, he said. But others worried about the United States' emphasis on imposing import quotas on Japan.
The breakdown of the talks and subsequent saber-rattling by U.S. officials was enough to scare Japanese investors. The Nikkei 225 Index plunged 5% on Feb. 14 and 15, dropping to 18974.60, before stabilizing on Feb. 16 at 19052.11. The market closed at 18931.39 Feb. 17, down 120.72.
And the yen rose as high as 101.90 to the dollar, its six-month peak, as the market believed the United States would pursue a strong-yen policy in response to the failed negotiations. A stronger yen would make U.S. exports to Japan cheaper, and would help trim Japan's burgeoning balance-of-payments surplus, which soared to $6.11 billion in January, up 17% from year-earlier figures. The surplus stood at $120.4 billion for 1993.
But there are flaws in that thinking. A strong yen would devastate Japanese exports, a major underpinning of the Japanese economy. Many Japanese businesses cannot make money with the dollar trading at 102, experts said.
What's more, a continued strong yen could create "catastrophic deflation in Japan," said Marcus Grubb, chief international equity strategist for Salomon Brothers International Ltd., London. If that were to happen, "all the bad loans would start to come out of the woodwork," he said, leading to a major bank collapse.
"Either there has to be more reductions in interest rates or something has to be done to weaken the yen," Mr. Grubb added. Some managers believe the yen will weaken by 10%, sliding back to a range between 115 and 120 by year-end.
Still, money managers are leaning toward boosting their long-depressed allocations to Japanese stocks.
"We think most of the bad news already is in the price," said Alastair Begg, chief investment officer of Kleinwort Benson Investment Management, London, which recently raised its Japanese equity holdings to 25% from 18% in non-U.S. portfolios.
A survey by Smith New Court Securities Ltd., London, taken before the trade talks failed, said a net of 50% of 91 U.K. money managers plan to increase their holdings of Japanese stocks, showing strong sentiment in favor of the market.
And, January's 16.2% stock-market gain largely was fueled by foreign investors betting on an economic recovery after seeing runups of more than 100% in some Southeast Asian markets, although Japanese investors were passive.
Some think the Japanese economy is bound to recover after four long and depressing years. "You rarely see a country that goes into a terminal decline and never recovers," said Laurence Beard, Japanese portfolio manger for the 6 billion ($8.85 billion) Shell Contributory Pension Fund, London.
But others say it's too soon to tell. Gerald Smith, a fund manager at Baillie Gifford & Co., Edinburgh, thinks the Japanese economy remains pretty weak with no signs of any significant recovery within sight. "We've not been joining in the buying," he said.
Many money managers, believing a consumer-led recovery is needed, praise the latest economic stimulus package that was adopted by the Japanese government, providing some 15.25 trillion ($148 billion) in income tax cuts and spending programs.
The package - the fourth in 14 months - is the only one to include tax cuts, which will generate refund checks in June and December. But it's far from clear how much of the checks will be saved and how much will be spent. And their net effect may be to offset slashed bonus payments to employees.
In addition, many experts said the package contains the usual mixture of "smoke and mirrors," so the real stimulus amounts to about half of the headline figure. Still, that could boost economic growth by 0.5% to 1%, some said.
Investors don't expect the economy to pick up steam until at least the second half. Many expect earnings growth to be substantial, but that's not hard from the current depressed levels.
While some investors still are leery of Japan's lofty price-to-earnings levels, David Thomas, senior vice president, Putnam Investments, Boston, noted other measures are in line with other markets.
At 2.3, the price-to-book ratio is "quite reasonable," and price to sales and price to cash flow ratios are cheap compared to other countries, he said.
Putnam raised its Japanese allocation in Pacific Basin portfolios to 35% from 20% (Japan's weighting in the MSCI Pacific Basin index is 76%). Putnam also plans to increase Japanese holdings in its international portfolios to 25% - the average for money managers - from 18%.
The promise of stronger earnings has caused many investors to shift toward cyclical stocks. Rowe Price-Fleming's Mr. Warren is buying Amada Co. Ltd., a machine tool manufacturer and Mitsui Petrochemical Industries, while Mr. Thomas likes Yamatake-Honeywell Co. Ltd., a factory control equipment company and is looking at steel-company stocks.
Rosemary Sagar, vice president at GE Investments, Stamford, Conn., which has been keeping its Japan holdings low, has a core holding in Ito-Yokado Co. Ltd., a retailer, but also likes SECOM Co. Ltd., which makes electronic security systems, a growing business in Japan.
Meanwhile, David Currie, head of the Japan department for Edinburgh Fund Managers PLC, Edinburgh, freshly returned from a visit to Japan, said he is buying Mori Seiki, a machine tool manufacturer with a strong balance sheet; Dai-ni Den Den Corp., a long-distance telephone service provider and a maker of cellular telephones that is benefiting from deregulation; and Nikon Corp., which produce cameras and semiconductors.