Japan in focus

In the latest of his series on investment abroad, Liam Robb asks, could now be the moment when the Japanese stock market at last begins to take a turn for the profitable?

When a leading chain of sushi restaurants goes down the pan leaving debts of over pounds 650m - and this in Japan, the spiritual home of raw fish - then investors in Japanese equities can be forgiven for becoming a little edgy. A quoted company with nearly 900 outlets, Kyotaru recently became the first business listed in the top tier of the Tokyo Stock Exchange to go bankrupt, in more than three years.

If further proof were needed, then a glance at the financial pages should provide it: the five worst-performing unit and investment trusts over one, three, five and 10 years all include a Japan fund.

While the stock-markets of all Western economies have recently reached all-time highs, the Nikkei 225 - the most widely observed indicator of market performance - has, in sterling terms, dropped by nearly 30 per cent in 12 months. Even interest rates of 0.5 per cent have failed to stimulate the demand from foreign investors that the market so desperately needs.

It is a far cry from the days of the late Eighties when the country enjoyed its boom years and the Nikkei stood at nearly 40,000 - more than twice today's level. During that bullish period, capital expenditure soared, creating an "asset bubble" which pushed valuations on property and equities to levels which were quite simply unsustainable.

"And ever since then the stock-market has been shedding the overly optimistic premium investors had attributed to it," explains James Salter, manager of the Schroder Japan Growth Fund. "The government has attempted to implement measures to stem the market tail-off, and has injected something like Y65 trillion (pounds 33bn) into the economy - the biggest fiscal stimulus any OECD country has seen since the Second World War - but while this has helped to some extent, investors have still to be convinced that the economy is genuinely back on track."

Poor fundamentals have much to do with the severe share price declines: a slow-down in economic growth (even the optimists expect GDP growth to remain below 2 per cent this year), a large budget deficit, and continuing poor corporate earnings.

An additional concern for investors is the Japanese government's plan to introduce a consumption tax - broadly equivalent to our VAT - at the end of March. The new tax, which is expected to be set at between 3 and 5 per cent, is likely severely to dampen domestic retail sales.

One or two rays of hope pierce the economic gloom. The Bank of Japan, for example, has been successful in its efforts to reduce the strength of the yen, which for so many years stymied Japanese industry. At its peak in May 1995 there were 133 yen to the pound; the exchange rate now stands at about 200.

The weakening currency has ensured that, while overall returns of the 1,700 companies listed on the Tokyo Stock Exchange have been amongst the worst in the world (with the banking, steel and petrochemical sectors having all performed especially poorly), some individual blue chips with large overseas exposure have done exceptionally well.

The share prices of Honda, TDK and Sony, for example, have all recently reached all-time highs. Canon, the camera and office equipment manufacturer, recently announced a 56 per cent increase in profits, fuelled by a weak yen (the company derives 80 per cent of its sales revenue from abroad) and a strong demand for computer-related products. Such companies' heavy weighting in the Nikkei has protected the index from even sharper falls.

Schroders is still relatively bullish on the pharmaceuticals sector. Sankyo, which has done particularly well in the States on the back of an oral anti-diabetic drug, is particularly in favour. Electronics companies with an international presence, such as Matsushita Electrical Industries (MEI), are also on the buy-list.

"Overall, however, the next six months will be very difficult to call," says James Salter. "The economic background is still uncertain and for the next two years Japan will remain a stock-pickers market." And the next real bull run? "We will probably not see it until Japanese industry has really grasped the nettle of share-holder value," he saysn

Performance Statistics: Datastream. Best performing Japan unit trusts over the past year include GT's Japan Growth and Schroder's Tokyo Inc. Best performing investment trusts include Fleming's Japanese and GT (again) Japan.