Report
On Business, The Globe and Mail, October 17, 1998
In 1990,
Montrealer Sid Klein bettered 5,002 challengers and pocketed
$500,000 (U.S.) in prize money by turning an imaginary $500,000 portfolio into
nearly $1.7 – million over three months in a stock contest for USA
Today/Financial News Network. How?
By correctly predicting the implosion of the Japanese stock market.
He’s staked his ground in the bear camp ever since – until now. Mr. Klein, whose views have been solicited by
Barron’s magazine and who publishes a daily financial newsletter, sees a
bottom forming under the Nikkei and a bull market of historic proportions in the
making. The possible bankruptcy of
Japan’s Long Term Capital Bank, a development Mr. Klein has predicted
in his newsletter, strikes him as similar to the final stages of the U.S.
banking crisis of 1932, which marked the bottom of the Great Depression.
Special
to The Globe and Mail
On Dec.
29, 1989, Japan’s benchmark Nikkei 225 index closed at 38,915.87, marking the
apogee of one of the most spectacular asset bubbles in the history of financial
markets. Over the next few months,
the Nikkei fell steadily lower as the fatal flaws masked through the 1980s by
Japan’s awesome economic success were revealed.
By late
1990, the Nikkei had retreated to the 20,000 level and would tumble to 15,000
two years later. Since then, the
market has made several runs higher, only to fall back from these peaks to
around 13,000 now.
At every
subsequent top since the crash, I remained bearish. I felt the depth of the crisis was being concealed and
foreigners over-owned Japanese stocks – while Japanese corporations were
dumping shares along with the government.
Now, all
those conditions are nicely reversed: Corporations
are buying back their shares, foreign investors have bailed out – with the
exception of the big, export stocks that track the Dow Jones industrial
advantage – and the debt problem is finally being addressed.
For these reasons, I believe the Japanese market is close to a true
bottom, and an historic buying opportunity is in the making.
Numerous quality companies are being set up for a new bull market that
could include 50-per-cent gains over perhaps the next six months.
Here’s
why the sun is rising – finally – over Japan’s battered market:
Taxation
I
predict taxes, which have been depressing the commercial and residential real
estate market, will be dismembered and corporate tax rates will be slashed more
than six percentage points by year-end. Taxes
that are cut will mean little lost revenue the government while driving real
estate prices dramatically higher. The will slash the now exaggerated bailout cost assumptions
by improving the balance sheets of the shaky financial sector.
Real
estate and bank reform
Emulating
a 1960 program that was the most successful five-year plan in Japan’s history,
Prime Minister Keizo Obuchi has announced the intention to legislate the
doubling of available land for housing over the next five years while creating
500,000 jobs over the next two years. More
affordable housing will boost demand for real estate and related housing
products.
Accounting
reforms will allow Japan’s 19 largest banks to increase the value of their
real estate on the books by 3.5 trillion yen (29.4-billion U.S.), affecting bank
capital similarly, which increases their capacity to lend and to take writedowns
to eliminate the bad debts without fire sales of assets.
Over the past 10 years real estate prices have fallen about 50 per cent
and these measures will ignite a massive consumer turnaround that will take
certain local companies to record highs. It’s
notable that foreign direct investment – particularly from the United States
– is focusing on the same areas.
Demographics
Much is
made of the negative implications of Japan’s demographics, namely record low
birth rates. The bigger picture is
that the rest of Asia has stunningly bullish demographics, and as both the key
economy and the biggest investor in the region, Japan will be the main
beneficiary.
Liquidity
Another
plank in Japan’s recovery will be improved liquidity. In 2000 and 2001, about $368-billion of Japanese savings will
be shifted to investment trusts – equity mutual funds – from
government-controlled pension schemes.
Major
players in the financial industry are forming alliances to market these trusts
to the public following deregulation. The
market will rally well ahead of this flood of new investment capital, pushing
stocks higher. Other massive
capital pools will also be available.
The
government will make about 200 billion yen available for smaller companies that
will enjoy lower borrowing costs while being virtually assured of a loan for any
reasonable purpose. Also on cue,
corporate Japan has registered to buy back 20 per cent to 25 per cent of its
shares. Mergers and acquisitions
are rocketing in number, as is foreign direct investment that has profited by
the same decline in the yen that has hurt portfolio investors.
Psychology
and leverage
On the
eve of the crash in late 1989, the facilitation of short selling began so that
Japanese could unwind stock holdings in a discreet manner to deflate the asset
bubble. Now, the government is
preparing short-selling curbs that will take effect before the end of the year,
which will support the market.
Consumers
will gain confidence – and start spending again – as the Nikkei climbs
higher, and as reforms and the bailouts work to strengthen the economy.
The opposite is true in the United States, where the flagging market will
undermine consumer spending. The
always-wrong-about-Japan mavens don’t understand that repatriation for the
banking bailout was behind the Dow’s recent plunge.
Japanese repatriation will continue to push many stocks higher – while
undermining Wall Street. It seems
clear – the shift of investment funds to Japanese markets is a no-brainer for
one looking ahead, seeking to keep his gains and looking for more.
Yen
internationalization
Japan
has just announced that re-purchase facilities now exist for Asian central
banks. These banks will now be able
to swap yen bonds back to the Bank of Japan for local currency when quick cash
is needed. This is crucial because
it makes the holding of a yen a more attractive prospect for Asian central banks
and should facilitate the move out of the U.S. dollar, which has been the
currency of choice in recent years. As
an example of how little yen Asian banks now hold, China has about $141-billion
worth of foreign reserves of which only 8 per cent is in yen, while 62 per cent
is in dollars. This clearly shows
the potential future demand for yen.
The new
efficiency
Record
high employee turnover, downsizing, share buybacks, the unwinding of cross
holdings and the closing of government agencies, along with half the banks over
the next two years, will all contribute to a dramatic improvement in earnings
for Japanese companies. In fact,
operating earnings are already starting to improve because of cost cutting,
though this is being masked by security writeoffs.
The
great opportunity
Similar
to the American experience in 1929-32, some Japanese stock market measures show
losses of up to 90 per cent. In
relation to the Dow, the losses on the Nikkei 225 are about the same.
As the Japanese tried to reflate without taking the writeoffs that are
occurring now, cheap capital went into U.S. stocks while the Nikkei languished,
which further shows the monumental effect Japanese capital repatriation will
continue to have.
These 90
per cent swings in value this decade point up the obvious opportunity.
Unlike Americans, Canadians can enjoy a currency in the yen that has not
recently rocketed against ours, and is in fact down sharply, though it has
turned. A rising yen along with a
rising Japanese stock market will magnify the gains for Canadian investors.
The
bottom line
This
quarter will mark the key buying opportunity in Japan this decade for many
Japanese stocks. I recommend
focussing on certain retail, finance, brokerage, bank, auto and solid,
domestic-oriented growth companies. (There
is also an extensive warrant market that offers the more aggressive investor
dramatic leverage). I would avoid
companies, like the big exporters that profit from a weak yen or companies
heavily exposed to the U.S. market. In
essence then, I favour companies that will prosper as demand recovers in Japan
and the rest of Asia.