Yen Pushes Ever Closer to JPY100 Milestone

Yen-selling market interventions by Japanese monetary authorities seem to have already reached 6 trillion yen so far this month, are on pace to exceed the previous monthly record of 5.11 trillion yen set last September. The official figures for the interventions will not be known until they are announced by the Finance Ministry at the end of the month, but funds that have flowed into the money markets since the beginning of January already total about 6.4 trillion yen, exceeding earlier projections. The record for interventions in a single year was 7.6 trillion yen in 1999 before it was surpassed by the 20 trillion yen of last year. At the current rate, this month's interventions could hit this figure for all of 1999.


(TT's Take) Our stance has been for the last six months or so that the yen was headed for a run at the old high of JPY79/US$ high, despite massive intervention by the Bank of Japan. Last week, currency markets were abuzz with talk that Toyota had purchased currency options with a strike price of JPY101 by August of this year. It appears that Japan's exporters are trying to position themselves for the possibility that the yen will break through JPY100/US$ this year.


In the December Tankan, companies surveyed replied that they were assuming an average JPY111 per dollar in the second half of FY03. If the yen were to appreciate to JPY90 per dollar and stay there indefinitely, it would trim all industry reported sales by 0.8%, and operating profits by 0.3%. In manufacturing, sales would be trimmed by 1.7%, while operating earnings would shrink by 8.4%.


So far, the pain of the strong dollar has been alleviated by a weak yen against the Euro, where it is estimated that a 1% appreciation in the Euro against the yen produces a windfall of JPY32 billion for corporate profits. However, the impact of the strong yen is first psychological, negatively affecting investor sentiment in export-related companies, and business confidence. This will be particularly true when the yen breaches JPY100/$. Consequently, investors remain cautious of exporters with high US dollar exposure, and instead are looking for late-coming digital electronic consumer goods producers with less dollar exposure, and domestic companies that will be benefitting from the end of deflation in Japan.

TSE Plans Real Time Disclosure of Major Corporate Announcements

From February 1, 2004, the Tokyo Stock Exchange will begin releasing corporate announcements such as earnings revisions, mergers and other market-moving announcement on their web page, following a move by the FSA to relax insider trading restrictions behind the current "12-hour rule". Under this rule, companies were required to disclose material information to two or more media sources and wait 12 hours or more before disclosing these announcements on their and other web pages.


All listed company announcements will be subject to the new practice, or some 3,200 companies, including those listed on the JASDAQ, and the regional exchanges. To prevent companies from just disclosing the information through the TSE web site and leaving it at that, the TSE will continue pushing companies to continue as they have distributing announcement materials and having media announcements.

Growing Concerns About Rush of New Stock Issues in 2004

In 2004, the government plans to sell off more of their holdings in NTT (about 1 million shares), Japan Tobacco (289,000 shares), JR West, and an additional issue of the Japan Petroleum Exploration Co. (JPEX) which was just listed Tokyo Stock Exchange on Dec. 10. Then there is Shinsei Bank, semiconductor producer Elpida Memory, a 50:50 JV between NEC and Hitachi in DRAMs, and J Power, among others. This year, some 150 new companies could be listed, versus 121 last year. The value of these new issues could reach JPY4 trillion, an increase of 54% or more from the previous year, and the highest level since the IT bubble burst in 2000.

Govt Sees 2% Or Higher Nominal Economic Growth From FY06

The government expects the Japanese economy to achieve at least 2% growth on a nominal basis beginning in fiscal 2006, according to a medium-term economic and fiscal outlook released Friday by the Council on Economic and Fiscal Policy (CEFP). The outlook is based on Cabinet Office estimates, which forecast a nominal gross domestic product growth of 2.1% in fiscal 2006, outstripping the 2% growth in real GDP adjusted for inflation. One more year than initially expected will be needed to overcome deflation, according to the outlook. The Cabinet Office expects consumer prices to rise in fiscal 2005, but projects that the GDP deflator, a gauge for overall price trends, will not turn positive until fiscal 2006. This represents a setback for the government, which, according to the previous revision, had hoped to end deflation in fiscal 2005. When Prime Minister Junichiro Koizumi took office in April 2001, the government's goal was to overcome deflation in fiscal 2003.


On the fiscal front, the government aims to bring the primary balance deficit of the cental and local governments into surplus in fiscal 2013. The primary balance, a measure of a nation's fiscal soundness, factors out government bond issuance and debt servicing costs. The primary balance deficit is expected to continue shrinking due to the government's efforts to curb general expenditures and slash tax grants to local authorities. The primary balance as a percentage of GDP is projected to improve by 0.8 percentage point on the year to a negative 4.6% in fiscal 2004 and turn into a positive 0.1% in fiscal 2013. But the primary balance estimate assumes that the government will raise income and consumption taxes in fiscal 2005 or later as part of its pension system reform, bringing in extra tax revenue totaling 3 trillion yen. It also assumes that public works spending will be cut by 3%.

(TT's Take ) The government is expected to remain heavily dependent on bond issuance to cover spending, with new bond issues estimated at 35-40 trillion yen each year through fiscal 2008. Thus the government will likely be forced to raise taxes aggressively given the prospect that the budget deficit is not expected to turn into a surplus by early next decade. This could well stifle the rosy midterm economic growth outlook that the government was trying to paint in the report.


Abating deflation slowing evolving into inflation is now an investment scenario that investors are starting to discount. Foreign investors returned to buying Japan with the onset of the new year, and apparently are looking for "end of deflation" investment stories. Last week, they were buying real estate stocks and non-bank financial consumer credit companies. At the same time, they have become less enthusiastic about lower quality basic materials companies, as these stocks as a group have been consolidating globally. In digital consumer electronics, the search is for late-comers.

Nikkei

2Shinsei Bank To List On Tokyo Stock Exchange Feb. 19

Shinsei Bank, which took over operations from the defunct Long-Term Credit Bank of Japan, announced Friday that it will list its shares Feb. 19 on the Tokyo Stock Exchange. The investment partnership that owns Shinsei Bank, led by U.S. investment firm Ripplewood Holdings LLC, holds a little more than 1.35 billion of its common shares. The shares to be offered will equal one-third of that amount, about 440 million, and the initial public offering price will be set Feb. 9 after gauging the demand from investors. That price is drawing speculation from investors. Shinsei Bank projects a net profit of 65 billion yen for the year ending March 31. Many market-related personnel contend that the bank's price earnings ratio -- the price of a stock divided by its earnings per share -- should be about 20 compared with the major banks' slightly more than 10. This is because it has few bad loans and shareholdings, and its revenue that does not come from interest, such as from its investment bank operations and business of reselling bad-loan credits, is strong.


When looking at just the common shares, its earnings per share would be a little more than 45 yen, leading to an initial offering price of about 900 yen. However, some say that the 669 million preferred shares held by the government must also be taken into consideration. The time limit for converting those preferred shares into common shares is some years ahead -- 2007 and 2008 -- but if they are taken into account, the bank's earnings per share will be a little more than 30 yen and the share price will be about 600 yen. Still, Ripplewood and the other foreign investment firms stand to gain a huge profit from the public offering in exchange for the risk they took in investing funds to rehabilitate the bank's management. If the initial offering price is 600-900 yen per share, then the stocks that they own will be worth 800 billion yen to 1.2 trillion yen.

When they assumed control of operations, they invested 1 billion yen to purchase shares of Long-Term Credit Bank from Deposit Insurance Corp. and another 120 billion yen for a third-party allocation of shares to increase capital. Ripplewood and the others will retain two-thirds of the common shares to maintain control of management, but the offering of the remainder next month alone will be enough to recover their previous investments.


(TT's Take)
The cost to the Japanese government (and taxpayers) was huge. Based on Deposit Insurance Corp. documents, the public funds injected into the bank total about 7.8 trillion yen. The entire amount that the government put up to cover the liabilities in excess of assets at the time of the management transfer is expected to be lost, and the tax revenue was used for 90% of that amount. Also, it is still unclear how much of the assets that it had bought, such as loan credits and shareholdings, can be recovered, but that is also expected to lead to a big loss. The total loss to the government will depend on the price that its preferred shares can fetch. The conversion price has been set at 360 yen and 600-800 yen for injections in 1998 and 2000, respectively. And if the share price at the time of sale is higher, the government will net the difference as profit. Based on all of these factors, the government's loss may total about 5 trillion yen. From the Japanese government and taxpayer's standpoint, the critics of the sale to the Ripplewood Holdings consortium were right, the government made a bad trade when they sold the bank--i.e., JPY7.8 trillion cost versus an JPY800 billion to JPY1.2 trillion profit that went to a "foreign" investor.


However, this is the first and the most visible success story in rehabilitating Japan's banking sector. Just as foreign-owned Nissan became the poster child for restructuring and reorganization in manufacturing, Shinsei has become the poster child for restructuring Japan's banking sector, as its business model is now significantly different than the major banking groups that basically represent (with the exception of Tokyo Mitsubishi) the pooling of "loser" banking groups considered too big to fail.

Nikkei

Greater China Tops U.S. As Japan's Leading Export Market In '03

Japanese exports to mainland China, Hong Kong and Taiwan in 2003 exceeded those to the U.S. for the first time.
According to Ministry of Finance trade figures, the balance of exports to China, Hong Kong and Taiwan for the first 11 months of 2003 totaled 12.34 trillion yen, up 19.5% over the same period the previous year, while exports to the U.S. were 12.29 trillion yen and down YoY.


The China-Taiwan-Hong Kong market consumed 25% of all exports from Japan during the fiscal first half of 2003, which runs from April through September. As exports to China rise particularly sharply, the balance of goods shipped to that nation alone may soon exceed shipments to ASEAN. China is already the top importer of Japanese products.
Taiwanese and Hong Kong firms are increasingly establishing positions on the Chinese mainland. Exports from Taiwan to China in 2003 were up 22%. Many Japanese exports reach China through Taiwan and Hong Kong.


(TT's Take ) Japan not only relies on China for imports of such items as materials and food, it also uses the nation as a production base because of the low labor costs there. It exports such products as machinery, semiconductor parts and semifinished products, while importing steel and commodity-grade machinery.
Advantest (code: ) exports of semiconductor production equipment to China are expected to double to JPY7.0-JPY8.0 billion. Car sales in China were up 75% in 2003, leading Nissan (code: ) to introduce their high class sedan "Cima" from February of this year. On the other hand, there are growing signs of excessive investment in steel and cars in China, sending a warning to government officials in Tokyo (including the bank of Japan) that Japan's economy may be more exposed to a bubble bursting in China than to a slow-down in the US economy.

Nikkei

Cross-Holding Unwinding. Now More Selective

After having returned public pension money that they used to manage on the behalf of the government, corporate pension funds now have smaller numbers of stocks in their portfolios, and are becoming more passive in managing these assets.


Financial institutions such as the banks and the insurers on the other hand are now expected to become more selective in unwinding their cross-holdings, and carefully review business relationships and "profitability" before unloading these holdings. This means that whole-scale dumping of cross-holdings is likely to abate noticeably. Some insurers such as
Sompo Japan Insurance Inc. (8755) are adopting benchmarks for their approach. Sompo has adopted the International Quality Ranking (IQR) model developed by Standard & Poor's Corp. to select stocks. The IQR grades stocks on an eight-point scale -- from A-plus to D -- according to how appropriate they are as medium- to long-term investments. The evaluations are based on such factors as sales as well as profits and dividends per share over the past seven years, adjusting for changes in accounting methods and merger-and-acquisition activity.


Among U.S. firms, it has been shown that the better the ratings, the higher the returns over the long term. This seems true for Japanese companies as well. The average annual return on companies rated A-plus was 3.8% for the period between 1993 and 2002, while the figure was 0.1% for firms rated B and minus 1.4% for those rated C. Needless to mention, those companies rated "C" are on the short list to liquidate.


(TT's Take) Cross gearing between the banks and the insurance companies was tolerated by the financial authorities as it helped both financial institutions to prop up each others' balance sheets. Consequently, while the ranking system sounds good for public consumption, a lot of insurer holdings of bank stocks actually have nothing to do with their relative attractiveness as investments.


Moreover, while the banks are accelerating their cross-holding to meet the 2006 deadline to get these holdings within their core capital levels, life insurance companies are phasing out efforts to reduce their balance of shareholdings now that stock risks and concerns about a potential erosion in financial soundness are waning. The balance of shares at 41 life insurers totaled about 16.8 trillion yen as of Oct. 31, 2003, a year-on-year decline of 22.1%. In addition to increasing their stock sales, the life insurers carried out share write-downs to reflect significantly lower fair values. As a result, the percentage of stocks within their total assets fell to a low of 9.3%. Some in fact lik Daido Life Insurance Co. (8799) now intend to increase their shareholdings. Because of an improvement in its solvency margin ratio, Daido Life now has more leeway to invest in higher-risk stocks.

New Liquidity-Adjusted Topix 1000 Will Affect Prices of Individual Stocks

Companies with large of amounts of their stock held by parent companies or other group companies are concerned, and are asking the quant desks of the brokers how their stock might be affected by the whole-scale adoption of the Topix 1000, the TSE's new liquidity-adjusted index. Some analysts report that there will be an announcement of a shift to a liquidity adjusted Topix in early April. There is speculation this will also affect the futures and options special quotations in December of this year and June of next year.


GPIF Investment Committee chair Mr. Terada has his doubts about possible conflicts of interest from the stock exchange creating its own liquidity-adjusted index, but if the index is correctly done, he is willing to adopt it as a benchmark. Previously, the stock exchange had been negative about introduction of a liquidity-adjusted index, but given the more sanguine view of financial system risk and the rising stock market (plus pressure from domestic institutions), they are now eager to do so.


(TT's Take )Merril Lynch estimates that there is some JPY9 trillion in Topix-indexed funds, Daiwa estimates more like JPY14 trillion, while we estimate it is more like JPY15 trillion. Based on Merril's estimate, some JPY983 billion of funds would move, both on the buy side and the sell side of the transaction. However, there can also be expected a significant amount of arbitrage, as brokers take bets on the shift to a liquidity-based index, just as there has historically been significant arbitrage and speculation about which companies are "out" and which will be included in the periodic Nikkei 225 index constituent adjustments. In addition, much of the money managed for public pension funds, while all not formerly indexed, is "closet indexed", i.e., even active managers are not willing to take big bets on tracking errors with the Topix. Consequently, the actual impact will be larger than the estimates for how much money is in indexed funds.

Active Individual Trading Supports Tokyo Stock Exchange Volume

Daily trading value on the Tokyo Stock Exchange has continued at a high level with the start of 2004. With the exception of the first half-day of trading daily trading volumes have been exceeding JPY1 trillion. Supporting this high level of trading is active day trading by individual investors. According to DLJ Direct SFG, one of the main online brokers in Japan, dailing trading value in January is up 30% from December levels at about JPY39 billion per day. Retail broker Nikko Cordial is also reporting 10%-20% increases with the start of the new year. From 2003, securities taxation on stock trading was unified to capital gains on each transaction, and the option to tax securities transactions seperately was discontinued.


Like the US, the Japan market also experienced a significant increase in tax-loss selling in December, with individual investors being net sellers by JPY627.1 billion, the highest level of net selling since JPY789.6 seen in 1989. These sales produced a significant amount of available cash as individual investors unloaded most of the dogs they had been holding for the last several years.


(TT's Take) The upsurge in individual investor trading volumes is making the online brokers rich, but is not helping corporations transfer the significant amount of crossholdings held by the banks to other investors. The banks are accelerating their sales of stock holdings as the trading volumes and market prices rise, and will probably continue doing so until they have their holdings to well within their Tier 1 capital, as required by the FSA within the next two years.

No Let-Up in Japan's Liquidity Trap

Despite the Bank of Japan' quantitative monetary easing policy, the broader measure of money supply, or the total stock of money in the economy (M2+CD), marked a meager 1.7% growth in 2003, a sharp decline from the 3.3% rise the year earlier and the lowest level in a decade. In terms of broadly defined liquidity, which includes postal savings, investment trusts, government bonds, money supply scored a 1.1% increase in 2003, the slowest growth since 1981, when yearly statistic comparison became possible.


The lack of loan growth is the main culprit. Bank loans to companies and households have persistently been on the decline. Data released the same day by the BOJ showed that the balance of lendings by private financial institutions such as city and regional banks averaged 405.18 trillion yen in 2003, 4.8% below year-earlier levels and down for the seventh straight year.


(TT's Take) The long-depressed money supply growth is increasingly raising concern at the Council on Economic and Fiscal Policy about a clogged flow of money into the economy, i.e., a liquidity trap. Heizo Takenaka wants growth in money supply of at least 4% or so, but is short on specifics about how to get it.