The Inevitable Shift From Excess Liquidity Will be Negative for Stocks

Despite persisting worldwide deflationary concerns, international commodity prices have risen sharply. Investment funds that have swollen as a result of monetary easing in Japan and the U.S. are flowing into commodity markets, while emerging economies, including China, that supply low-priced products are increasing demand for raw materials and food.
But rising prices of materials cause problems for economic policies intended to counter deflation as well as for consumers and companies.


Even the price of coffee, soy beans and other agricultural commodities is rising. Coffee rose as much as 16% in January alone. The U.S. Commodity Research Bureau's futures index for coffee, a benchmark price index for the commodity, posted the highest level in about 20 years in January.



TT's Take Money inflows into funds that invest mainly in commodity futures amounted to $6.6 billion in the January-September period of last year, according to TASS Research. The working balance for the funds doubled to $19.5 billion during the same nine month period. Money from Japanese pension funds and individual investors is also flowing into investment trusts that incorporate commodity funds. By comparison, speculators' outstanding purchase contracts at the NYMEX total about $4 billion each for crude oil and gold, a level that cannot be compared with the scale of the U.S. stock market, which exceeds $10 trillion in aggregate market value. Investment funds are increasingly flowing into commodities.


Secular bull trends in commodities are inevitably followed by higher interest rates, and higher interest rates inhibit stock market rallies, especially when the markets shift gears from excess liquidity to earnings or fundamentals. Commodity prices soared from the 1970s, which saw two oil crises, to the 1980s. In those days, dollar crises and inflation became chronic amid declining confidence in the U.S. economy. The current increase in commodity prices is occurring in a quite different situation, namely, deflation.


Growing supply pressures from developing countries are pushing down prices of products, the Fed and the Bank of Japan have placed emphasis on checking deflation. Money that has swollen due to monetary easing measures that run the risk of inflation is heading toward the commodity market. Given the severe competition among companies, it is not easy for them to pass increases in material costs on to product prices. In Japan's consumer price index surveys for December, prices that rose from a year earlier were all in regulated fields, such as medical care, education, and fuel, electricity and water charges. Prices of furniture, household goods, clothing and food declined despite rising raw material prices. Many U.S. companies are boosting their productivity by accelerating capital spending, mainly in IT, even though their capacity utilization rates are at the 70% level. Growth in supply capacity will help to curb inflation by causing an oversupply in facilities and employment, while monetary easing for preventing deflation will cause speculative funds to increase.


As soon as they are able, companies will begin pushing through higher basic materials prices into selling prices, leading to inflation, which in turn will mean higher interest rates. When that happens, equity markets will consolidate, and the interim consolidation could be nasty, at least in the short-term.

Japan IT Investment Shows First Uptick in Three Years

The Japan User Association of Information System r eported Tuesday that its diffusion index of fiscal 2003 budgets for information technology rose for the first time in three years. The reading came to 13 in the latest report. The index is calculated by taking the ratio of companies that plan to increase investment in information technology and subtracting the ratio that plan to decrease such investment. In the latest survey, 47% of respondents said they plan to boost IT investment in fiscal 2003 compared with fiscal 2002, while 34% plan to cut such investment. The diffusion index peaked at 28 in fiscal 2000 and fell to a low of 9 in fiscal 2002. More firms in technology-dependent industries such as financial services and communications are increasing investments to boost their competitiveness. The association commented that while overall investment appears to be on the rebound, the amount spent on individual projects is still under downward pressure, which is constraining earnings for systems builders.


TT's Take IT investment in the US is also on the mend. But this so far is not helping Japan's IT bubble poster child, NTT DoCoMo (9437). Soaring marketing costs for its FOMA 3G (third-generation) mobile service could cause in fiscal 2004 to suffer its first year-on-year full-term profit decline. The cellular giant expects its group pretax profit to increase just 4% on the year this fiscal year through March 31. Analysts project an operating profit decline of about 6% next fiscal year. FOMA customers could quadruple to 10 million, but the faster FOMA's popularity grows, the more likely that the company's profit will decline. This is because the ARPU will likely fall 30% due to the FOMA service's lower fees for data transmission.


Expanded sales of the FOMA service may also lead to a surge in costs. And because prices of FOMA phones are about 10,000 yen higher than those of second-generation handsets, DoCoMo will have no choice but to comparably boost the marketing incentives that it offers to sales agencies if it wants to hold down retail prices and stay competitive. Furthermore, revenue from the FOMA service is not expected to expand substantially because 80% of FOMA phone buyers are existing customers who are upgrading their handsets. In the first half of fiscal 2003, an increase in the incentives paid to encourage a switch to camera phones caused DoCoMo's first operating profit decline. This year, the planned flat-fee data communications service may end up temporarily curbing revenue. With the FOMA service, the more DoCoMo wants to boost sales, the more it has to spend on marketing. Desperate to win the competition with KDDI(9433), however, DoCoMo "will not keep down sales for the sake of increasing profit," says Executive Vice President Masayuki Hirata, revealing a focus on market share over profit.


(The Nikkei Financial Daily Wednesday edition)

Takeover Bids Will Force Japanese Companies to Change

Steel Partners Japan Strategic Fund's takeover bid for Sotoh Co. (3571) has ended in failure (as many previous such attempts have), but the hostile attempt, which was rare in Japan, indicates that unsolicited takeover bids are beginning to force change at underperforming Japanese firms. The U.S. investment fund collected only 115,000 Sotoh shares, representing less than 1% of the total outstanding shares, through the bid. Nevertheless, Steel Partners forced the woolen-fabric dyer to increase dividends sharply. Yushiro Chemical Industry Co. (5013), which also fended off a hostile takeover bid by Steel Partners, ended up raising dividends as well.


Barbarians at the Gate. A U.S. investment fund led by noted investor Mason Hawkins has effectively become the largest shareholder in Nippon Broadcasting System Inc. (4660), which serves as the de facto holding company of Fujisankei Communications Group. Rumor has it that Fuji Television Network Inc. (4676), a core Fujisankei group firm, is desperately trying to reduce the investment fund's influence on its management through such means as share issuance. On the other hand, Ken Matsuzawa -- president of Nipponkoa Insurance Co. (8754), whose top shareholder is the U.S. fund -- treats Hawkins as a business partner, believing that the U.S. investor, a different breed of shareholder, will help energize his company.


TT's Take Barbarians or partners? The Ripplewood Holdings consortium of investors has shown that they can take over management and make a difference (at Shinsei). Renault has shown that they can take over Nissan and make a difference. On the other hand, M&A Consulting's Murakami has had a mixed track record, and forced only minimum change at Tokyo Style. Daimler is having a struggle with Mitsubishi Motors, as is Ford with Mazda. The overall record of foreign takeovers is mixed, but there still seems to be a higher degree of success from foreign takeovers as their is from domestic-domestic takeovers...

Yen Tanks as Trade Surplus Soars, Boosting Exporter Stock Prices

Japan's trade surplus jumped to JPY507.1 billion in January, up five-fold from a year earlier and substantially above expected levels. This was the 7th straight month of YoY increases. Exports were up 11.3% YoY, the highest ever level for a January. Exports to Asia were up 20.8%, up for the 23rd consecutive month, while exports to China soared 33.8% YoY to one-fourth all Asian exports. Euro-zone exports were up 11.2%, while exports to the US were down 5.4% YoY as auto exports fell 23.2% and were below JPY1 trillion for the first time since August 1996.


This notwithstanding, the yen weakened sharply to JPY109.39 during Monday, (Feb. 23), as traders evidently moved to adjust their dollar short positions, according to MOF Vice Finance Minister Mizoguchi.


TT's Take The combination of good trade numbers and the weak yen were a good boost for exporters, and auto stocks also rallied even though the auto export numbers were not good.