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Spotlight on: The Japanese Market
The Japanese Genie Escapes the Bottle
December 27, 2000
As investors with international interest wonder when foreign markets will break from trends driven by events in the US and Canada, there is some thinking that Japan might play a key role. At Frank Russell Company, Overseas Equity Portfolio Manager James Jornlin, promotes the idea that Japan's emergence from a transitional period for its society, its economy, and its financial markets could be the trigger.
"Over the past several years, the international investment landscape has been primarily drawn by events affecting the US economy and markets," Jornlin says. "The idea of a 'new' technology-based economy originating in North America, as well as interest rate judgements by the US Federal Reserve and the more recent uncertainty surrounding the presidential election, have significantly affected global markets. This has decreased the benefits of diversification into international markets. But American market dominance is unlikely a permanent phenomenon."
 Jornlin looks to the "Land of the Rising Sun" for new opportunities. True, the Japanese economy's recovery has been slow and investors who bought Japanese stocks in 1999 had cause to reassess their positions in 2000. "But," says Jornlin, "we're optimistic about Japan long-term. The problem is, most Western investors try to fit Japan into a North American model and don't understand Japanese culture and its impact on the Japanese economy and financial markets."
Jornlin hails William Arah, Director of Marathon London, one of Russell's non-US equity investment fund managers, as an expert with a unique perspective on the workings of Japan's recovery.
Saying goodbye to the corporation as social safety net
Arah believes that the infrastructure of the Japanese economy has undergone dramatic change but at a slow pace suited to Japanese cultural and societal norms. "Until recently, the Japanese system required the corporate sector to bear the nation's welfare obligation," Arah said. "Lifetime employment served as the cornerstone of that obligation. As a result, changes in corporate Japan involve not just ways of doing business but how society is run."
Changing social patterns is difficult anywhere. Japanese culture, however, prefers to arrive at broad consensus before making changes. The time necessary to achieve such consensus can be lengthy, particularly with an older, more conservative electorate. As Arah observes: "It is difficult to tell working people in their forties and fifties that lifetime employment is inefficient and should be abandoned. Change in Japan is painful."
That pain extends to Japan's old non-competitive business model, according to Arah. "The old model permitted many companies to survive within an industry. There was no competitive pricing and no quest for efficiency. The old corporate structure emphasized cross-shareholding, bank domination and relationships with multiple suppliers and distributors. Now, old links are being broken. Once-bitter foes are moving together, because the Japanese have accepted that global competitiveness requires cost-effective functions such as research and development and distribution."
A "tsunami" of mergers and acquisitions and consolidation
Reorganization and restructuring have moved forward. "In 1999, merger and acquisition activity was equivalent to about six percent of market capitalization," says Arah. "This is low by Western standards but off the charts for Japan. Joint ventures now taking place in the electronics industry would have been seen as a sign of weakness a few years ago. So, too, is an automotive company like Nissan, under Renault leadership, giving up all the parts subsidiaries it owns. It no longer feels obligated to support them and will now seek the best parts at the best prices."
The Japanese are also confronting the need for a secondary labor market. Companies must learn how to recruit workers with 10 or 20 years experience who have been let go. Workers, in turn, must learn how to sell themselves. About one-sixth of Japanese companies now offer stock options as management incentive, a situation reflecting the United States 20 years ago.
A long-term perspective
Arah emphasizes that the Japanese shift to a market-oriented economy requires patience.
"Many Western investors take a short-term view, looking for the momentum of returns from Japanese stocks. They really should be looking at the fundamental shifts the Japanese are making. Further, Americans have been saving at a low rate and will have to start saving more. When they do, relative returns in Japan will look more attractive. The US and Japanese markets will begin to separate themselves so that there will be little correlation between the two."
Japan may now be about to develop an individual financial identity due to new efficiencies and potential for higher returns created by the information age, the realization that the old model no longer works and the impact of global pressures.
"In direct contrast to the US, a decade of zero growth in Japan has seen investor expectations collapse and risk aversion sky rocket, and yet a host of new growth industries ranging from energy, automotive electronics, digital consumer products, mobile data and intelligent home systems — suggest that growth rates may be bottoming."
"The genie is out of the bottle," Arah asserts. "When it flexes its muscle remains to be seen, but the genie is definitely not going back."
As Jornlin evaluates his non-US portfolios, he considers the varied opinions of international managers and places significant weight in Arah's observations.
"Uncertainty puts a premium on a diversity of expert opinion and multiple sources of information. Bill Arah's understanding of Japan lends a very different perspective. Looking at international markets from a bit different angle may be critical to achieving favorable investment results. Without question, Japan will play a major role in a changing international marketplace."
International markets entail different risks than those typically associated with domestic markets, including currency fluctuations, political and economic instability, accounting changes, and foreign taxation. Securities may be less liquid and more volatile.
Copyright© Russell Investments Canada Limited 2000. All rights reserved. Date of first use: 12/27/00.
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