Why the sun is rising over Japan once again


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.


Sid Klein

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:




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.




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.




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.

With quality industry leaders expanding operations in preparation for the coming boom and debt-free companies poised for explosive earnings and trading below share-holder equity, relatively low-risk stock portfolios may enjoy 50 per cent total returns on a mere move back to the 17,000s by the Nikkei, while offering quality long-term investment that should yield strong double-digit gains for Canadian institutional, corporate and individual investors over the longer term.