Japanese Market Outlook, July 1998

Market rises as decisions madeTOPIX surged 6.5% last week as the government brought out its Total Plan for Financial Rehabilitation and then topped it off with suggestions from PM Hashimoto that permanent tax cuts should be implemented from next year. Although the bridge-bank scheme may not work out as neatly in practice as it appears on paper, the fact that the government was racing towards a decision instigated a round of short-covering, leading to a gain in the market which encouraged additional money to come in. As a result, foreigners appear to have become buyers last week for the first time in 17 weeks. Although the Nikkei has risen for eight straight days for the first time since Feb 91, TOPIX has declined for two days in a row, pulled down by bank shares. The forex market has not been as keen on the Total Plan as the stock market has, and that may be why Mr Hashimoto reversed course on permanent tax cuts last Friday. A less charitable view about last week's rally is that the substance of Japan's economic policy is now being set in Washington (discreetly, of course), and that investors will benefit as Japan is transformed into a consumer society and speeds the clean-up of its bad-debt mess with Yankee resolve.

Permanent tax cutsAside from a cut in the top tax rate from 65% to 50%, the LDP also proposes that the floor for the minimum tax rate be lowered and that taxes be raised on pension payments and on interest income. Although few details have yet been decided, it is possible that the flat tax rate of 20% on interest income will be raised to the marginal tax rate, a move which would hurt savers (but might encourage consumption). The proposals should be good for continued gains in retail stocks. Department stores (4.9% outperformance last week), superstores (+7.2%) and consumer-electronics retailers (+7.2%) are still quite low relative to their 20-year trading ranges. Marui (+1.7%) and Ito-Yokado (+3.3%) are very close to their all-time relative highs.

"Tokuseirei"The word "tokuseirei" is popping up more frequently these days, in reference to the possibility that some of the debts owed by construction and real-estate companies could be forgiven. The government has been considering policies related to debt forgiveness (see Walter Altherr's Apr 23rd report entitled "Banks' tax write-offs for debt forgiveness"), and support for the idea has come from MOF Minister Matsunaga: "the law provides for the abandonment of loans; it does not mean that special benefits are being given to certain debtors. If the parties involved agree, it can speed up the resolution of the bad-debt problem." The word itself comes from the Muromachi period, when a decree by the shogun wiped out all the debts of certain loyal samurai. Some LDP members support debt forgiveness for real estate and construction on the view that it would improve the flow of money, get properties moving, generate profits and help out local economies. LDP member Uetake says that it is okay to adopt "tokuseirei" at times of social transition and that "in the current crisis, economic recovery is more important than fairness." Of course, if banks do

forgive loans to the bubble sectors, the cost will be borne by the taxpayer, since part of those losses can be written off against taxes. This week's Ekonomisto asserts that the LDP has a list of particularly weak real estate and construction firms, and that they may be willing to reveal the names of the very weakest to defuse public outcry at debt relief for the survivors. Construction bosses have not been shy about supporting the idea: "the government has kept interest rates at ridiculously low levels and arranged Y30 trillion to help out the banks; now it is our turn to get some help." And with 6.6 million employee/voters, help just might be on the way within this week.

Tax breaks on mortgage interest?But what about the poor schmucks who bought a house (in line with policies promoted by the government) anytime in the past 10-15 years and whose outstanding mortgages now exceed what they could get if they were to sell their homes, since land prices have gone down? If the LDP is going to forgive the debts of contractors and developers, shouldn't it also offer more tax benefits on the interest paid on mortgages? The Nihon Keizai Shimbun is advocating that such mortgage benefits be included with income-tax reductions, and in its Sunday editorial, it wonders why the LDP has never proposed better mortgage-interest tax benefits.

Let Yamanouchi payAs banks and contractors chalk up trillions in tax-loss carry-forwards, tax revenues are likely to remain depressed even after the economy recovers. MOF has just reported that tax revenues in FY97 fell Y1.5 trillion short of expenditures despite the Y5 trillion hike in the consumption tax!! To cover the shortfall, the tax authorities have apparently decided to shake down exporters such as Murata and Yamanouchi on their transfer pricing practices. After all, that is where the money is (and to think they made it all without any government help!).

Technical pictureLast week's rally leaves the market with a technical situation very similar to that of two previous bear-market bottoms, in Aug 92 and Jul 95. The Aug 92 bottom coincided with the first economic package and the start of PKO; the Jul 95 bottom marked the start of the effort to end the ultra-strong yen. The two previous rallies started with sudden bursts of gains, with the one in Jul 95 as mysterious as the one which occurred last week; they also featured several days of consecutive gains which led to extreme short-term overheating vs the 25-day m.a. (the swing in the spread vs the 25-day m.a. was from -8.1% to +14.9% over 8 days in Aug 92 and from -7.8% to +10.3% over 20 days in Jul 95; this time we have gone from -4.6% on Jun 16th to +7.37% on Jul 3rd). The early stage of the previous rallies were accompanied by big gains in low-priced speculative issues, a sign of recovering confidence that is evident again. Whereas the '95 leader was Kanematsu NNK (which rose from Y389 to Y3,470), this year's star is Ishikawa Mfg (up from Y49 to Y726 so far). Three stocks doubled last week. Overall volume has improved; the 54.7 mn shs traded in Nippon Steel last Wednesday was that stock's highest in 6 years. Finally, TOPIX last week managed to

get above its 13-wk, 26-wk and 200-day moving averages in a single bound, and the 26-week m.a. had already been in an uptrend for 2-3 weeks. Athough TOPIX was able to get above its 26-wk m.a. for a brief time in Feb 98, the 26-wk m.a. itself was in such a sharp downtrend that the TOPIX could not hold that level; now it has underlying support from this major m.a. Thus: although the fundamentals might be the worst we've had so far in the 1990s, and although it is not rational to expect that the leadership which has so badly managed Japan for the past decade can now set everything aright, the technical conditions are similar to those which led to a 47% gain in Aug 92-Jun 93 and to a 56% gain in Jul 95-Jun 96.

Winners and losersThe strongest subsectors last week were Cements +14.0% vs TOPIX, Sekisui Chemical +12.3%, Shipbuiding +12.3%, Spinning +10.3%, Trading Companies +9.0%, Plant +8.4%, MHI +7.5%, Real Estates +7.3%, Consumer-Electronic Retailers +7.2%, Superstores +7.2%, Electric Steels +6.7%, Big Steels +6.6%, Nichiei +5.8%, DDI +5.7% and Bearings +5.3%; the weakest subsectors were Secom -7.4% vs TOPIX, Blue-Chip Components -7.3%, Game Machines -6.1%, Gas -5.8%, EP -5.5%, Canon -4.9%, Rohm -4.2%, Telecom Construction -4.2%, Kyocera -3.8% and IC Chemicals -3.5%. Tires closed the week at a new relative high; there were no new relative lows.

Materials, machineries advanceDespite the 11.2% YoY decline in industrial production, and despite the fact that JF expects no YoY growth in industrial production for another 18 months, materials and machineries were among the market's biggest winners. Although steel inventories edged down 1.5% MoM, the inventory-to-shipment ratio rose; yet the steel sector rose 13.7% on huge volumes. The charts are extended over their 13-week moving averages, but major overhead supply is comfortably above current levels (roughly +22% to Y330 on Nippon Steel, +40% to Y200 on Kobe, +45% to Y1,100 on Tokyo Steel). An update on the bearings industry by Hoshino-san suggests downward revisions will be coming, yet the group has outperformed by 36.5% YTD and 5.3% last week. Incongruous outperformance was also seen last week in Construction Machinery +3.8%, Big Chemicals +2.3% and Machine Tools +2.1%. Similarly, the cable sector rebounded from 5 months of underperformance with a relative gain of 3.9%, even though shipments in May were down 42% for optical fiber aand 16% for copper cables. Does the market expect industrial recovery sooner than economists do?______________

Market Outlook, July 13-17

The election and the marketAs we write on this Sunday of the Upper House election, we do not yet know if the LDP managed to win the 61 seats needed to declare victory, but the history of the past elections suggests that the market will go up whether the LDP wins or loses. In the '92 election

(when the LDP won big), the Nikkei was up about 5% one month after the election; in '95 (when the LDP was humbled), the market gained about 10% in the subsequent month. Volumes tapered off late last week as the LDP's standing in the polls waned, mainly because of PM Hashimoto's flip-flop statements on tax cuts. Despite the market's distaste for Mr Hashimoto, it probably would prefer the LDP to win back its 61 seats so that the Total Plan for Financial Revitalization bills can get through the upcoming Diet session smoothly and so that the LDP can make good on its international promise to pass permament tax cuts.

Technical pictureThe technical situation is still bullish (ie, still above 13-wk and 26-wk moving averages), but not as positive as a week ago. Having declined in 5 of the past 7 sessions, TOPIX has dropped below its 200-day m.a., and volume has been easing off since the peak of 924 mn shs on July 2nd. Once TOPIX had rebounded to 1,270, it started running into increased selling pressure because 1) it was approaching the Feb high of 1,300 and 2) it was above the March close of 1,251.70, which means that domestic institutions could start realizing profits. This they did, since every category of domestic investor sold into the rally. It was surprising to find that individual investors boosted their net selling in the week of the rally to Y162.4 bn, the highest level since Apr 96. Given last week's big volumes and extremely big gains in low-priced stocks, we had assumed that individuals were coming back into the market as they did in the summers of '92 and '95. Alas, it was only dealers; there is no new money coming into equities from individuals yet. The 6.5% rally in TOPIX in the week ended July 3rd was led entirely by foreigners (whose Y323.9 bn of net buying was the highest since Mar 96) and dealers (Y103.9 bn).

Winners and losersThe strongest subsectors last week were Consumer-Electronics Retailers +10.6% vs TOPIX, Blue-Chip Components +6.2%, Discounters +5.9%, Restaurants +5.7%, Trucks +4.8%, Housing Materials +4.7%, TV Broad-casters +4.7%, Software +4.3%, Downstream Chemicals +4.3%, Kyocera +4.3%, Game Machines +4.1%, Rohm +3.8%, Turnaround Components +3.7%, Precisions +3.4%, Nonferrous Metals +3.2%, Fuji Film +3.2% and the OTC Index +3.1%; the weakest subsectors were Cements -11.3% vs TOPIX, Spinning -6.9%, DDI -6.6%, Airlines -6.5%, Trust Banks -6.4%, General Contractors -5.2%, Sekisui Chemical -5.1%, Big Steel -4.95%, SPE -4.6%, Shipbuilders -3.7%, Construction Machinery -3.7%, Gas -3.4%, Warehouses -3.3% and IBJ -3.1%. New ten-year relative highs were achieved by Kao, Restaurants and JR East; new relative lows by Spinning, Trust Banks and Airlines.

Controlled InflationThe concept of "controlled inflation" got a lof of attention last week as a new panacea for Japan's economic problems. The idea is that the BOJ should target a certain level of acceptable inflation (say 3-4%) by injecting funds into the money markets with the aim of creating negative long-term interest rates and instilling in consumers an expectation that

inflation will continue. The concept is advocated by Paul Krugman in his recent essays on Japan's Liquidity Trap and has been supported by Professor Itoh of Tokyo University, Mr Ueda of the BOJ, Mr Yamasaki of the LDP and others. JF's Chris Calderwood doubts that BOJ efforts to achieve a targeted inflation rate would be successful, mainly because much of the extra yen created would join the capital flight (net portfolio outflow in June exceeded Y1 trillion) and lead to a crash in the yen. Other skeptics think that any BOJ effort to create inflation would either overshoot (ie, they wouldn't be able to stop it at 3%) or else lead to stagflation (the recession continues, but with inflation). Whatever comes of this debate, it did lead to weakness in both the yen and JGBs last week.

Weak-yen beneficiariesThe 1.5% rise in dollar/yen last week did not help all exporters equally. Backed by strong Play Station sales and positive domestic sales in June, Sony is steadily approaching its all-time high (Jan 98) of Y12,700. Aiwa just set a new high (Y4,750) on July 2nd and Sony Music (Y6,190) is marching towards its Mar 94 high of Y6,780. Other strong electricals include MEI, MCI, Alps, CMK, Rohm, Murata and Nichicon. However, the big electricals remain sluggish despite a few positive signs coming from the US (SOX index rising, PC stocks surging, Windows 98 off to a strong start) and Intel suppliers Ibiden and Shinko Electric have fallen into downtrends. Keyence fell further and has underperformed by 23% YTD; it has not participated in the recent rally in other machinery groups such as Machine Tools +28% vs TOPIX YTD and Bearings +47% YTD. The Auto sector is being led by Honda (new all-time high of Y5,250 on Friday), Fuji Heavy and Nissan Diesel; Toyota (-3.6% last week) can't seem to break through its declining top pattern.

Retail stocks rallyThe Consumer-Electronics Retailers was the strongest subsector last week, backed by reports of a few days of strong air-conditioner sales and indications that the World Cup generated some demand for new TVs and VTRs. The stocks are still bombed out, well below the levels of 18 months ago, and seem to be in the early stages of recovery. Of course, skepticism about the recovery prospects remains deep, especially since consumer sentiment surveys are hitting new lows just as unemployment is hitting new highs. Restaurants are a surprise, as they have moved to a new all-time relative high. Denny's is in the strongest uptrend while Skylark is in the youngest. Last week Shimamura surged on strong June sales, Shimachu poked above its moving averages as if it wants to move back to its old trading range around Y3,500 (+42% from here), Seiyu surged on record volume following bullish comments from ING Barings and Izumi (17.7X PER, 0.75X PBR, mkt cap Y56.8 bn) has one of the best charts in the market. Izumi's chart is reminiscent of Kokusai Securities in late February, when it rose to Y1,150 to break out of its base; last week it closed at Y1,550 (34.8% above its post-breakout price).

JF still bearishJF's new Quarterly reports on the economy and strategy maintain decisively bearish views, with the economy seen staying mired in recession for another 18 months and with the

market vulnerable to a level of 13,500 or below. Both reports emphasize the problem of excess supply (of production capacity, labor, debt, inventory, etc) and hold that real recovery cannot come until those excesses are corrected. Giles Ockenden's strategy note (p5) argues that big companies have to be more aggressive in cutting labor costs in order to bolster OP margins. One company which is ahead of the pack in this regard is Mitsui M&S, whose president was interviewed in this week's Nikkei Business. Since nonferrous metals companies faced deflationary forces long before the rest of Japan did, President Miyamura's response provides a good model for other companies. He 1) cut labor costs by eliminating automatic pay hikes from 1996, found 600 employees to take early retirement, and now bases bonuses on consolidated profits, 2) closed down loss-making divisions/subsidiaries and 3) is shrinking the balance sheet. Directors' pay is linked not ony to profit performance, but also to how much they reduce debt. As a result, debt has declined by 12% over the past 3 years and Mitsui last year earned the same net profit as Mitsubishi Materials with only 35% of Mitsubishi's sales. Capex is focused on competitive areas like copper foils, Ni-Cd batteries and LCD films.

Softbank, Acom into new marketsAt a time when most of corporate Japan is reeling from declining sales and high fixed costs, a few companies (such as Aiwa and NIDEC) are expanding aggressively. Last week Softbank used some of the $650 mn it raised from the listing of Ziff Davis to expand its exposure to the internet juggernaut. Although the valuations on Yahoo! are staggering for most investors, Softbank decided to put another $250 mn into the stock at its current market price. Then last Friday it announced a $400 mn investment for a 27.2% stake in E-trade, on the conviction that on-line investment wil be one of the biggest growth areas on the internet. Meanwhile, Acom has signed on to start issuing MasterCards from next year, and may follow with e-money services on MasterCard's Mondex system. This kind of diversification should bring some revaluation to the consumer finance stocks, which have underperformed by 17% YTD. As Walter Altherr has observed, Travelers (Salomon Smith Barney) has its origins in a sarakin company--the old Commercial Credit Corp.

Market Outlook, July 21-24

Couldn't afford Hashimoto any moreLast week was full of surprises. The Hashimoto cabinet suffered a resounding defeat, even as the nation's major newspapers predicted in their election-day issues that the LDP would win around 55 seats. Despite the uncertainty about new leadership, the stock market recovered quickly from its opening sell-off to post a gain of 2.9% for the week; despite the fact that Mr Obuchi looked to be a shoo-in to become the next PM, the markets did not plunge as predicted; and despite the decision by Mr Kajiyama to run, the market did not surge as predicted. As the LDP pols spent the week wheeling-and-dealing, the stock market and the yen both gained ground, probably because they sense that the worst is over now that Hashimoto is gone. Although there was no shortage of reasons for Hashimoto's defeat (the worst GDP decline since WWII, rising bankruptcies and unemployment, vacillation about

permanent tax cuts), perhaps the main reason was that the silent majority in Japan realized that they just couldn't afford him more. Think of the costs that he has run up for the Japanese people during his public service. He was the transport minister who forbad the JNR Settlement Corp from selling land in the late 1980s, lest the sales lead land prices higher. Cost: the JNR debt doubled from Y15 tr to around Y27-28 tr. He was finance minister when the Miyazawa cabinet introduced lending restrictions on real estate--after the bubble had already burst and prices were going down anyway. Cost: tens of trillions of yen in lost real-estate values, hurting everyone from corporate borrrowers to banks to individual home owners. And of course he was the prime minister who raised taxes and fees by Y9 trillion in FY97, promising everyone that the economy would still grow at least 1.9%. Cost: a decline of Y3.5 tr in real economic activity, a shortfall of Y1.5 tr in tax revenues, a 16.4% rise in the number of bankruptcies, record job loss and a surge in problem debt at lending institutions to Y87.5 tr (17% of GDP). No wonder Sony's Mr Ohga described him as the "Herbert Hoover of Japan" and no wonder the electorate decided they couldn't afford him any more. It will be up to Hashimoto's successor to become Japan's Roosevelt.

Candidates' policiesAll three candidates favor a clear turn away from the recent fiscal-reform policies, which is positive for growth and for the stock market. However, one wonders why Mr Obuchi wants to add a Y10 tr supplementary budget before any of the Y16.6 tr package has been implemented. Mr Koizumi's proposal to abolish (not just postpone) the Fiscal Reform Law represents the greatest turn, since he was a staunch advocate of fiscal reform as Hashimoto's health & welfare minister. All candidates support permament tax cuts, which is also good for the stock market. Mr Obuchi favors Y6 tr in cuts and is the first LDP leader to advocate tax breaks on mortgage interest, so his election could expand the burgeoning rally in housing stocks (Tostem is back to Y2,000!). All three candidates also support stabilization of the financial system, with Mr Kajiyama having the most detailed (and aggressive) plan and nobody specifically mentioning bridge banks. All favor more disclosure and more responsibility by bank management, but only Mr Kajiyama has advocated that drastic surgery be completed within two years, by forcing the banks to increase reserves for all categories of problem loans, liquidating those banks that run out of capital and replacing top management as a precondition for injection of public money. However, as part of a safety net, he favors increasing lending by govt financial institutions to Y20-30 tr: surely the huge losses by special corporations and third party sectors show that govt banks have no more prudence than private ones. Everybody in the LDP still thinks that the credit crunch means that there are not enough loans available, yet the new figures for all 959 banks, credit unions and ag co-ops show total loans are Y795 tr (157% of GDP!!) and 11% of those loans are doubtful. Mr Kajiyama also expressed support for cultivating high tech and software industries, two industries which have done well despite perenniel neglect by the LDP. Imagine how much stronger Japan's high tech could become if it was supported by favorable policies rather than merely being taken for granted as a source of tax revenues and foreign exchange. Both Mr Obuchi and Mr Koizumi favor cuts in the size of

government officials/bureaucrats, with Mr Koizumi also favoring a halving of the seats in the Diet.

Technical pictureThe technical condition of the market is conducive to further gains. TOPIX moved back above its 200-day m.a. last Monday and now stands 2.63% above it; the 200-day m.a. itself has been declining about 3 points per week, but will start rising in a few weeks as long as TOPIX does not collapse in the meantime. A Golden Cross of the 25-day and 75-day m.a. lines adds support to a bullish view. The near-term challenge is for TOPIX to get above its Feb-Mar highs of around 1,300, but the reason that it has made little headway over the past 12 trading days is probably that it is absorbing the selling that comes out as it approaches those previous rally highs. There also continues to be selling by domestic funds which marked portfolios to market at the end of March, as well as steady unwinding of cross holdings. The market also features bold new break-outs to all-time highs (Sony, Honda, Bridgestone, JR firms, Unicharm), several sectors apparently moving into new uptrends (roads, plant, air-conditioning contractors, big chemicals, glass, ceramics, steels, metal products, machine tools, shipbuilders, low-priced autos, second-line precisions, superstores), and improving patterns in small stocks (with two IPOs last week opening at significant premiums). All of this in a market weighed down by banks, general contractors and real etates.

GEC acquires Lake

GE Capital showed its faith in Japan's nonbank business by agreeing to acquire Lake, the fifth largest sarakin which has been receiving assistance from Mitsui Trust since 1992. Following news that Acom will start issuing MasterCards from January, the TSE Nonbank Index outperformed TOPIX by 5.1% last week. The Nonbank Index is still only 7.6% above its mid-June relative low, and 19% below its Jan 98 high. Given that a smart player like GEC is willing to take over a troubled sarakin, fund managers should feel more confident about investing in the cheap, relatively untroubled sarakin like Takefuji and Aiful. Now that GEC has taken over several nonbanks since it acquired Minebea Finance in 1994, it appears it apparently aims to become a full-line provider of financial services similar to ORIX, which closed last week just Y70 short of its all-time high.

Environmental hormonesNick Smith's recent report on PVCs and the Environment appears to be at the forefront of a broadening concern about the negative impact of chloride compounds on the environment. There have been more articles in the popular press about the hazardous environmental hormones which are produced when these compounds (used in building materials, car seats, wrapping materials, etc.) are incinerated Now a brand new tome on the problem has just appeared by Takashi Tachibana, Japan's formost journalist best known for breaking the Lockheed scandal in Bungei Shunju 22 years ago. The beer companies have just

announced that they will no longer use PVC in advertising boards and, as Nick predicted, the PVC industry is fighting to hold on to customers. Nevertheless, a full awareness of the problem has not yet hit the stock market: although Shin-Etsu is down 3% so far this month (vs the 3.9% gain in TOPIX), Kaneka has risen to Y800 for the first time since Oct 94.

Buddha is backAlong with recent fads such as camisole dresses, big bookstores and assembly-line sushi shops, young consumers have rediscovered an interest in Buddhist images. The trend got started with a manga by Miura Jun and has been supported by several new guidebooks on Buddhist images, including a book/video set by Benesse. A rock group has been bringing a statue of Miroku Bosatsu on stage and the Butsu Trick Bar in Shibuya offers cold drinks in the reposeful presense of a giant sitting Buddha. So far the fad seems limited to a superficial interest in the attractive faces of Buddhist images rather than a search for consolation in Buddhist teachings, so it does not seem to have deep enough roots to benefit related stocks such as Matsui Construction or Hasegawa. But if it reaches the LDP it could be good for Mr Kajiyama, whose face resembles that of a big, happy, prosperous Buddha.____________

Market Outlook, July 27-31

Mr Ordinary does the usualMr (Ordinary) Obuchi started off his new role as leader of the LDP by doing the usual thing: selecting three new party leaders based on factional balance. Although he claims that the appointments were his own judgement. in fact his representatives threw the Mitsuzuka faction into a tizzy by asking who was responsible for personnel in the faction. The tussle between supporters of Mr Kamei and Mr Mori has created a cleft in the faction, as Mr Mori was appointed LDP Secretary General. The two other appointments were based on recommendations of two henchmen from the Hashimoto Cabinet: Mr Kato (Miyazawa faction) proposed Mr Ikeda as Policy Research Chairman and Mr Yamazaki (ex-Watanabe faction) proposed Mr Fukuya as General Council Chairman. Mr Yamazaki (remembered for his failed effort to talk the Nikkei up to 18,000 by end March) has ingratiated himself to Mr Obuchi by describing him as "the father of the people" (as if this were Indonesia), and Mr Obuchi told Mr Yamazaki that "someday I would like to return the favor." Thus, it appears that the Obuchi administration will be run by the same people who ran the Hashimoto government, and that the Obuchi faction has already promised to support Kato/Yamazaki in the next election in return for the votes they just gave to Mr Obuchi. Thus there is little hope that the people's favorite, Mr Koizumi, will have much of a chance within the LDP even in the next election.

Selection of cabinetMr Obuchi will select his cabinet by July 30th, and he is likely to fill it with heavyweights to make up for his own lightness. He has indicated that some ministers could come from the

private sector, though the MOF portfolio will probably go to a politician given the sensitive issue of allocating tax money to clean up the bad-debt problem. It is still possible that Mr Kajiyama could become the next MOF Minister, but the odds are against because 1) his calls for radical surgery on the bad-debt problem are too drastic for Mr Obuchi and 2) the Obuchi faction had pretty much ostracized Mr Kajiyama even before he decided to run, as it distrusts him because he maintains ties with the hated Ozawa.

Economic Strategy ForumMr Obuchi plans to set up an economic council of academics, economists and businessmen to advise him on the best economic policies to get the economy growing again. Taichi Sakaiya, a well-known author and ex-MITI man, is lilely to lead the group. Mr Obuchi can certainly use the advice, as one of his hare-brained ideas is to distribute Y5 tr of his proposed Y10 tr economic package to local governments in a repeat of PM Takeshita's 1988 Furusato Plan, when Y100 mn was given to every municipality to use as it pleased.

New policy mixWith its call for bigger tax cuts and increased fiscal spending, the new administration will move away from PM Hashimoto's policy mix of stringent fiscal spending/low interest rates to a mix of generous spending/low interest rates. Whereas Hashimoto's policies were wonderful for bonds and bad for stocks and real estate, Obuchi's mix should be more favorable for stocks and somewhat negative for bonds. However, reckless spending on more unneeded projects in the regions will accelerate the deterioration of Japan's public finances and thereby fully justify Moody's recent assesment that Japan has "deep structural problems" and "a lack of consensus on ow to solve them."

Technical pictureThe technical condition remains good, as TOPIX found support at its 200-day m.a. last week and remains above its 13-wk and 26-wk moving averages. It is unfortunate that volume has been declining again, and that much of the volume is in declining stocks such as trust banks, but the market last week not only resigned itself to an Obuchi victory, but also shook off the threatened downgrade of Japan's rating by Moodys and the year's first bankruptcy of a listed construction firm. Investors who use magazine covers as contrary indicators will start putting more money into Japan: last week Time's cover was "Can Anyone Save Japan" while Newsweek's was "Japan's Lost Decade." Aug 3rd will bring two new issues to the First Section (Aeon Credit and Paris Miki), and it is hoped that they can do as well as last spring's new listings of Hamamatsu Photonics (+50% since listing in March) and Union Tool (+18% since listing in May). Recent OTC listings have been opening at premiums, and this Tuesday's start of trading in Digi-Cube could bring interest to game software stocks.

Winners and losersThe strongest subsectors last week were Keyence +6.4% vs TOPIX, Cements +5.6%, Secom +4.9%, Precisions +4.7%, Kyocera +4.4%, Blue-Chip Components +4.4%, Electric

Steels +4.2%, Construction Macinery +3.4%, Shipping +3.1%, Gas +3.1%, NTT Data +3.0% and TSE Nonbanks +3.0%; the weakest subsectors were Trust Banks -8.2% vs TOPIX, Plant Engineers -5.3%, Real Estate -4.4%, Consumer-Electronic Retailers -3.5%, Apparel -3.0%, Ito-Yokado -2.5%, IBJ -2.4%, MHI -2.3%, TSE Bank Index -2.3% and Major City Banks -2.1%. New ten-year relative highs included Kao, Tires, Consumer Electricals, Blue-Chip Components and JR East; new relative lows included Spinning Companies, TSE Bank Index and Trust Banks.

Hoya should go higherHoya's shares rose 15% last week on 3.4 mn shs, its biggest weekly volume in four years, after Q1 consolidated results revealed strong sales growth in 3-4 niche areas and continued cuts in costs. Head count was reduced despite the growth in sales and profits. Hoya also disclosed its consolidated cash flow statement (which will be required by all companies from the Mar 00 term), with Y5.6 bn in free cash flow. The stock should be given a premium for its success in maximizing returns on shareholder assets, and a return to its Aug 97 high of Y6,460 would give it a PER of 35X Fujino-san's estimates for FY99, about the same rating given to Ricoh and a bit cheaper than Keyence. Local investors such as Tokio M&F Asset Management have started basing their stock-selection on cash flow (as opposed to profits), and JF's full company reports have been including cash flow statements since spring. Nomura's transport analyst explained the strong performance of JR East on its generation of positive free cash flow, whereas the private rail stocks are stuck near a 12-year relative low.

Sumitomo Bank's disclosureSumitomo Bank last week gave investors some more detail about last year's results. Of last year's gross profits, 52% came from retail banking, 26% from trading, 10% from international and 9% from wholesale banking. Of the 254.7 bn in unrealized gains on its portfolio of listed shares, almost all (Y249.6 bn) comes from manufacturing companies. It has gains of Y31.6 bn on utilities, Y7.9 bn on services and Y2.3 bn on real-estate shares, but losses of Y23.3 bn on construction, Y7.4 bn on wholesale/retail and Y5.6 bn on financials.

Convenience store bluesThis week's Ekonomisto carries the laments of five former operators of convenience stores (though none from 7-Eleven), and underscores the risks to new franchisees while suggesting that the royalties charged (65% of gross profits at Family Mart, for example) are exorbitant. Among the complaints: new stores often fail to achieve the daily sales promised by the convenience-store company; even if the sales estimates are achieved, operators are surprised by how much they have to pay out for scrapped products, inventory losses and labor; 15-year contracts make it hard for operators to quit even after they realize they have made a mistake; a former franschisee for Hot Spur said that fewer than 10% of franchisees renew their contracts; Mr Oyama, whose Circle K stores was shut down by the company in

a widely reported incident at the end of January, says that almost all franchisees used to come from mon-and-pop owners of rice shops and liquor stores, but that these people now saw little benefit in becoming a franchisee so that now 65-70% of new operators are former salarymen. Even operators of company-owned shops have trouble making ends meet. If investors have been negative on sarakin stocks on the view that their juicy margins are not sustainable, perhaps they should be more negative on high-margin convenience stores as well.

Bubble sectors languishDespite Mr Obuchi's promise of a new Y10 tr economic package, the General Contractors underperformed by 1.45% last week; they have underperformed by 31% since their recovery peak in mid-March and now stand only 17% above their 10-year relative lows of January. Real Estates, having formed a double bottom relative to TOPIX in Jul 92 and Nov 94, then outperformed by 50% to their recent peak in mid-Oct 97. Since then they have underperformed by 22% and stand only 10% above their '92 and '94 lows. Trust banks plummeted to yet another 10-year relative low last week, yet still stand 25% above their Jul 81 low. These poor showings suggest that the market does not believe the LDP's new reflation policies will be successful.______________Market Outlook, July 13-17

The election and the marketAs we write on this Sunday of the Upper House election, we do not yet know if the LDP managed to win the 61 seats needed to declare victory, but the history of the past elections suggests that the market will go up whether the LDP wins or loses. In the ‘92 election (when the LDP won big), the Nikkei was up about 5% one month after the election; in ‘95 (when the LDP was humbled), the market gained about 10% in the subsequent month. Volumes tapered off late last week as the LDP’s standing in the polls waned, mainly because of PM Hashimoto’s flip-flop statements on tax cuts. Despite the market’s distaste for Mr Hashimoto, it probably would prefer the LDP to win back its 61 seats so that the Total Plan for Financial Revitalization bills can get through the upcoming Diet session smoothly and so that the LDP can make good on its international promise to pass permament tax cuts.

Technical pictureThe technical situation is still bullish (ie, still above 13-wk and 26-wk moving averages), but not as positive as a week ago. Having declined in 5 of the past 7 sessions, TOPIX has dropped below its 200-day m.a., and volume has been easing off since the peak of 924 mn shs on July 2nd. Once TOPIX had rebounded to 1,270, it started running into increased selling pressure because 1) it was approaching the Feb high of 1,300 and 2) it was above the March close of 1,251.70, which means that domestic institutions could start realizing profits. This they did, since every category of domestic investor sold into the rally. It was surprising to find that individual investors boosted their net selling in the week of the rally

to Y162.4 bn, the highest level since Apr 96. Given last week’s big volumes and extremely big gains in low-priced stocks, we had assumed that individuals were coming back into the market as they did in the summers of ‘92 and ‘95. Alas, it was only dealers; there is no new money coming into equities from individuals yet. The 6.5% rally in TOPIX in the week ended July 3rd was led entirely by foreigners (whose Y323.9 bn of net buying was the highest since Mar 96) and dealers (Y103.9 bn).

Winners and losersThe strongest subsectors last week were Consumer-Electronics Retailers +10.6% vs TOPIX, Blue-Chip Components +6.2%, Discounters +5.9%, Restaurants +5.7%, Trucks +4.8%, Housing Materials +4.7%, TV Broad-casters +4.7%, Software +4.3%, Downstream Chemicals +4.3%, Kyocera +4.3%, Game Machines +4.1%, Rohm +3.8%, Turnaround Components +3.7%, Precisions +3.4%, Nonferrous Metals +3.2%, Fuji Film +3.2% and the OTC Index +3.1%; the weakest subsectors were Cements -11.3% vs TOPIX, Spinning -6.9%, DDI -6.6%, Airlines -6.5%, Trust Banks -6.4%, General Contractors -5.2%, Sekisui Chemical -5.1%, Big Steel -4.95%, SPE -4.6%, Shipbuilders -3.7%, Construction Machinery -3.7%, Gas -3.4%, Warehouses -3.3% and IBJ -3.1%. New ten-year relative highs were achieved by Kao, Restaurants and JR East; new relative lows by Spinning, Trust Banks and Airlines.

Controlled InflationThe concept of “controlled inflation” got a lof of attention last week as a new panacea for Japan’s economic problems. The idea is that the BOJ should target a certain level of acceptable inflation (say 3-4%) by injecting funds into the money markets with the aim of creating negative long-term interest rates and instilling in consumers an expectation that inflation will continue. The concept is advocated by Paul Krugman in his recent essays on Japan’s Liquidity Trap and has been supported by Professor Itoh of Tokyo University, Mr Ueda of the BOJ, Mr Yamasaki of the LDP and others. JF’s Chris Calderwood doubts that BOJ efforts to achieve a targeted inflation rate would be successful, mainly because much of the extra yen created would join the capital flight (net portfolio outflow in June exceeded Y1 trillion) and lead to a crash in the yen. Other skeptics think that any BOJ effort to create inflation would either overshoot (ie, they wouldn’t be able to stop it at 3%) or else lead to stagflation (the recession continues, but with inflation). Whatever comes of this debate, it did lead to weakness in both the yen and JGBs last week.

Weak-yen beneficiariesThe 1.5% rise in dollar/yen last week did not help all exporters equally. Backed by strong Play Station sales and positive domestic sales in June, Sony is steadily approaching its all-time high (Jan 98) of Y12,700. Aiwa just set a new high (Y4,750) on July 2nd and Sony Music (Y6,190) is marching towards its Mar 94 high of Y6,780. Other strong electricals include MEI, MCI, Alps, CMK, Rohm, Murata and Nichicon. However, the big electricals remain sluggish despite a few positive signs coming from the US (SOX index rising, PC stocks surging, Windows 98 off to a strong start) and Intel suppliers Ibiden and Shinko

Electric have fallen into downtrends. Keyence fell further and has underperformed by 23% YTD; it has not participated in the recent rally in other machinery groups such as Machine Tools +28% vs TOPIX YTD and Bearings +47% YTD. The Auto sector is being led by Honda (new all-time high of Y5,250 on Friday), Fuji Heavy and Nissan Diesel; Toyota (-3.6% last week) can’t seem to break through its declining top pattern.

Retail stocks rallyThe Consumer-Electronics Retailers was the strongest subsector last week, backed by reports of a few days of strong air-conditioner sales and indications that the World Cup generated some demand for new TVs and VTRs. The stocks are still bombed out, well below the levels of 18 months ago, and seem to be in the early stages of recovery. Of course, skepticism about the recovery prospects remains deep, especially since consumer sentiment surveys are hitting new lows just as unemployment is hitting new highs. Restaurants are a surprise, as they have moved to a new all-time relative high. Denny’s is in the strongest uptrend while Skylark is in the youngest. Last week Shimamura surged on strong June sales, Shimachu poked above its moving averages as if it wants to move back to its old trading range around Y3,500 (+42% from here), Seiyu surged on record volume following bullish comments from ING Barings and Izumi (17.7X PER, 0.75X PBR, mkt cap Y56.8 bn) has one of the best charts in the market. Izumi’s chart is reminiscent of Kokusai Securities in late February, when it rose to Y1,150 to break out of its base; last week it closed at Y1,550 (34.8% above its post-breakout price).

JF still bearishJF’s new Quarterly reports on the economy and strategy maintain decisively bearish views, with the economy seen staying mired in recession for another 18 months and with the market vulnerable to a level of 13,500 or below. Both reports emphasize the problem of excess supply (of production capacity, labor, debt, inventory, etc) and hold that real recovery cannot come until those excesses are corrected. Giles Ockenden’s strategy note (p5) argues that big companies have to be more aggressive in cutting labor costs in order to bolster OP margins. One company which is ahead of the pack in this regard is Mitsui M&S, whose president was interviewed in this week’s Nikkei Business. Since nonferrous metals companies faced deflationary forces long before the rest of Japan did, President Miyamura’s response provides a good model for other companies. He 1) cut labor costs by eliminating automatic pay hikes from 1996, found 600 employees to take early retirement, and now bases bonuses on consolidated profits, 2) closed down loss-making divisions/subsidiaries and 3) is shrinking the balance sheet. Directors’ pay is linked not ony to profit performance, but also to how much they reduce debt. As a result, debt has declined by 12% over the past 3 years and Mitsui last year earned the same net profit as Mitsubishi Materials with only 35% of Mitsubishi’s sales. Capex is focused on competitive areas like copper foils, Ni-Cd batteries and LCD films.

Softbank, Acom into new markets

At a time when most of corporate Japan is reeling from declining sales and high fixed costs, a few companies (such as Aiwa and NIDEC) are expanding aggressively. Last week Softbank used some of the $650 mn it raised from the listing of Ziff Davis to expand its exposure to the internet juggernaut. Although the valuations on Yahoo! are staggering for most investors, Softbank decided to put another $250 mn into the stock at its current market price. Then last Friday it announced a $400 mn investment for a 27.2% stake in E-trade, on the conviction that on-line investment wil be one of the biggest growth areas on the internet. Meanwhile, Acom has signed on to start issuing MasterCards from next year, and may follow with e-money services on MasterCard’s Mondex system. This kind of diversification should bring some revaluation to the consumer finance stocks, which have underperformed by 17% YTD. As Walter Altherr has observed, Travelers (Salomon Smith Barney) has its origins in a sarakin company--the old Commercial Credit Corp.

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Market Outlook, July 21-24

Couldn’t afford Hashimoto any moreLast week was full of surprises. The Hashimoto cabinet suffered a resounding defeat, even as the nation’s major newspapers predicted in their election-day issues that the LDP would win around 55 seats. Despite the uncertainty about new leadership, the stock market recovered quickly from its opening sell-off to post a gain of 2.9% for the week; despite the fact that Mr Obuchi looked to be a shoo-in to become the next PM, the markets did not plunge as predicted; and despite the decision by Mr Kajiyama to run, the market did not surge as predicted. As the LDP pols spent the week wheeling-and-dealing, the stock market and the yen both gained ground, probably because they sense that the worst is over now that Hashimoto is gone. Although there was no shortage of reasons for Hashimoto’s defeat (the worst GDP decline since WWII, rising bankruptcies and unemployment, vacillation about permanent tax cuts), perhaps the main reason was that the silent majority in Japan realized that they just couldn’t afford him more. Think of the costs that he has run up for the Japanese people during his public service. He was the transport minister who forbad the JNR Settlement Corp from selling land in the late 1980s, lest the sales lead land prices higher. Cost: the JNR debt doubled from Y15 tr to around Y27-28 tr. He was finance minister when the Miyazawa cabinet introduced lending restrictions on real estate--after the bubble had already burst and prices were going down anyway. Cost: tens of trillions of yen in lost real-estate values, hurting everyone from corporate borrrowers to banks to individual home owners. And of course he was the prime minister who raised taxes and fees by Y9 trillion in FY97, promising everyone that the economy would still grow at least 1.9%. Cost: a decline of Y3.5 tr in real economic activity, a shortfall of Y1.5 tr in tax revenues, a 16.4% rise in the number of bankruptcies, record job loss and a surge in problem debt at lending institutions to Y87.5 tr (17% of GDP). No wonder Sony’s Mr Ohga described him as the “Herbert Hoover of Japan” and no wonder the electorate decided they couldn’t afford him any more. It will be up to Hashimoto’s successor to become Japan’s Roosevelt.

Candidates’ policiesAll three candidates favor a clear turn away from the recent fiscal-reform policies, which is positive for growth and for the stock market. However, one wonders why Mr Obuchi wants to add a Y10 tr supplementary budget before any of the Y16.6 tr package has been implemented. Mr Koizumi’s proposal to abolish (not just postpone) the Fiscal Reform Law represents the greatest turn, since he was a staunch advocate of fiscal reform as Hashimoto’s health & welfare minister. All candidates support permament tax cuts, which is also good for the stock market. Mr Obuchi favors Y6 tr in cuts and is the first LDP leader to advocate tax breaks on mortgage interest, so his election could expand the burgeoning rally in housing stocks (Tostem is back to Y2,000!). All three candidates also support stabilization of the financial system, with Mr Kajiyama having the most detailed (and aggressive) plan and nobody specifically mentioning bridge banks. All favor more disclosure and more responsibility by bank management, but only Mr Kajiyama has advocated that drastic surgery be completed within two years, by forcing the banks to increase reserves for all categories of problem loans, liquidating those banks that run out of capital and replacing top management as a precondition for injection of public money. However, as part of a safety net, he favors increasing lending by govt financial institutions to Y20-30 tr: surely the huge losses by special corporations and third party sectors show that govt banks have no more prudence than private ones. Everybody in the LDP still thinks that the credit crunch means that there are not enough loans available, yet the new figures for all 959 banks, credit unions and ag co-ops show total loans are Y795 tr (157% of GDP!!) and 11% of those loans are doubtful. Mr Kajiyama also expressed support for cultivating high tech and software industries, two industries which have done well despite perenniel neglect by the LDP. Imagine how much stronger Japan’s high tech could become if it was supported by favorable policies rather than merely being taken for granted as a source of tax revenues and foreign exchange. Both Mr Obuchi and Mr Koizumi favor cuts in the size of government officials/bureaucrats, with Mr Koizumi also favoring a halving of the seats in the Diet.

Technical pictureThe technical condition of the market is conducive to further gains. TOPIX moved back above its 200-day m.a. last Monday and now stands 2.63% above it; the 200-day m.a. itself has been declining about 3 points per week, but will start rising in a few weeks as long as TOPIX does not collapse in the meantime. A Golden Cross of the 25-day and 75-day m.a. lines adds support to a bullish view. The near-term challenge is for TOPIX to get above its Feb-Mar highs of around 1,300, but the reason that it has made little headway over the past 12 trading days is probably that it is absorbing the selling that comes out as it approaches those previous rally highs. There also continues to be selling by domestic funds which marked portfolios to market at the end of March, as well as steady unwinding of cross holdings. The market also features bold new break-outs to all-time highs (Sony, Honda, Bridgestone, JR firms, Unicharm), several sectors apparently moving into new uptrends (roads, plant, air-conditioning contractors, big chemicals, glass, ceramics, steels, metal

products, machine tools, shipbuilders, low-priced autos, second-line precisions, superstores), and improving patterns in small stocks (with two IPOs last week opening at significant premiums). All of this in a market weighed down by banks, general contractors and real etates.

Winners and losersThe strongest subsectors last week were Nichiei +8.2% vs TOPIX. Consumer Finance +5.7%, Shipbuilders +4.1%, NTT +3.8%, Rohm +3.7%. Sekisui Chemical +3.4%, Apparel +3.3%, Fuji Photo +3.2%, Tires +2.7%, Glass +2.6%, Turnaround Components +2.5%, Game Machines +2.2%, Consumer Electricals +2.1%, Superstores +2.1% and NEC/Fujitsu +2.1%; the weakest subsectors were EP Construction -4.2% vs TOPIX, Consumer-Electronics Retailers -4.0%, General Contractors -3.8%, Cables -3.8%, DDI -3.7%, IC Chemicals -3.6%, Trucks -3.3%, Gas -3.2%, Real Estate -3.15%, Condos -3.1% and Nonferrous Metals -3.0%. New ten-year relative highs included Kao and Tires; the only new low was Trust Banks--a far cry from every other rally of the 1990s, in which Trust Banks were always the strongest outperforming subsector.

GEC acquires LakeGE Capital showed its faith in Japan’s nonbank business by agreeing to acquire Lake, the fifth largest sarakin which has been receiving assistance from Mitsui Trust since 1992. Following news that Acom will start issuing MasterCards from January, the TSE Nonbank Index outperformed TOPIX by 5.1% last week. The Nonbank Index is still only 7.6% above its mid-June relative low, and 19% below its Jan 98 high. Given that a smart player like GEC is willing to take over a troubled sarakin, fund managers should feel more confident about investing in the cheap, relatively untroubled sarakin like Takefuji and Aiful. Now that GEC has taken over several nonbanks since it acquired Minebea Finance in 1994, it appears it apparently aims to become a full-line provider of financial services similar to ORIX, which closed last week just Y70 short of its all-time high.

Environmental hormonesNick Smith’s recent report on PVCs and the Environment appears to be at the forefront of a broadening concern about the negative impact of chloride compounds on the environment. There have been more articles in the popular press about the hazardous environmental hormones which are produced when these compounds (used in building materials, car seats, wrapping materials, etc.) are incinerated Now a brand new tome on the problem has just appeared by Takashi Tachibana, Japan’s formost journalist best known for breaking the Lockheed scandal in Bungei Shunju 22 years ago. The beer companies have just announced that they will no longer use PVC in advertising boards and, as Nick predicted, the PVC industry is fighting to hold on to customers. Nevertheless, a full awareness of the problem has not yet hit the stock market: although Shin-Etsu is down 3% so far this month (vs the 3.9% gain in TOPIX), Kaneka has risen to Y800 for the first time since Oct 94.

Buddha is back

Along with recent fads such as camisole dresses, big bookstores and assembly-line sushi shops, young consumers have rediscovered an interest in Buddhist images. The trend got started with a manga by Miura Jun and has been supported by several new guidebooks on Buddhist images, including a book/video set by Benesse. A rock group has been bringing a statue of Miroku Bosatsu on stage and the Butsu Trick Bar in Shibuya offers cold drinks in the reposeful presense of a giant sitting Buddha. So far the fad seems limited to a superficial interest in the attractive faces of Buddhist images rather than a search for consolation in Buddhist teachings, so it does not seem to have deep enough roots to benefit related stocks such as Matsui Construction or Hasegawa. But if it reaches the LDP it could be good for Mr Kajiyama, whose face resembles that of a big, happy, prosperous Buddha.

Market Outlook, July 27-31

Mr Ordinary does the usualMr (Ordinary) Obuchi started off his new role as leader of the LDP by doing the usual thing: selecting three new party leaders based on factional balance. Although he claims that the appointments were his own judgement. in fact his representatives threw the Mitsuzuka faction into a tizzy by asking who was responsible for personnel in the faction. The tussle between supporters of Mr Kamei and Mr Mori has created a cleft in the faction, as Mr Mori was appointed LDP Secretary General. The two other appointments were based on recommendations of two henchmen from the Hashimoto Cabinet: Mr Kato (Miyazawa faction) proposed Mr Ikeda as Policy Research Chairman and Mr Yamazaki (ex-Watanabe faction) proposed Mr Fukuya as General Council Chairman. Mr Yamazaki (remembered for his failed effort to talk the Nikkei up to 18,000 by end March) has ingratiated himself to Mr Obuchi by describing him as “the father of the people” (as if this were Indonesia), and Mr Obuchi told Mr Yamazaki that “someday I would like to return the favor.” Thus, it appears that the Obuchi administration will be run by the same people who ran the Hashimoto government, and that the Obuchi faction has already promised to support Kato/Yamazaki in the next election in return for the votes they just gave to Mr Obuchi. Thus there is little hope that the people’s favorite, Mr Koizumi, will have much of a chance within the LDP even in the next election.

Selection of cabinet

Mr Obuchi will select his cabinet by July 30th, and he is likely to fill it with heavyweights to make up for his own lightness. He has indicated that some ministers could come from the private sector, though the MOF portfolio will probably go to a politician given the sensitive issue of allocating tax money to clean up the bad-debt problem. It is still possible that Mr Kajiyama could become the next MOF Minister, but the odds are against because 1) his calls for radical surgery on the bad-debt problem are too drastic for Mr Obuchi and 2) the Obuchi faction had pretty much ostracized Mr Kajiyama even before he decided to run, as it distrusts him because he maintains ties with the hated Ozawa.

Economic Strategy ForumMr Obuchi plans to set up an economic council of academics, economists and businessmen to advise him on the best economic policies to get the economy growing again. Taichi Sakaiya, a well-known author and ex-MITI man, is lilely to lead the group. Mr Obuchi can certainly use the advice, as one of his hare-brained ideas is to distribute Y5 tr of his proposed Y10 tr economic package to local governments in a repeat of PM Takeshita’s 1988 Furusato Plan, when Y100 mn was given to every municipality to use as it pleased.

New policy mixWith its call for bigger tax cuts and increased fiscal spending, the new administration will move away from PM Hashimoto’s policy mix of stringent fiscal spending/low interest rates to a mix of generous spending/low interest rates. Whereas Hashimoto’s policies were wonderful for bonds and bad for stocks and real estate, Obuchi’s mix should be more favorable for stocks and somewhat negative for bonds. However, reckless spending on more unneeded projects in the regions will accelerate the deterioration of Japan’s public finances and thereby fully justify Moody’s recent assesment that Japan has “deep structural problems” and “a lack of consensus on ow to solve them.”

Technical pictureThe technical condition remains good, as TOPIX found support at its 200-day m.a. last week and remains above its 13-wk and 26-wk moving averages. It is unfortunate that volume has been declining again, and that much of the volume is in declining stocks such as trust banks, but the market last week not only resigned itself to an Obuchi victory, but also shook off the threatened downgrade of Japan’s rating by Moodys and the year’s first bankruptcy of a listed construction firm. Investors who use magazine covers as contrary indicators will start putting more money into Japan: last week Time’s cover was “Can Anyone Save Japan” while Newsweek’s was “Japan’s Lost Decade.” Aug 3rd will bring two new issues to the First Section (Aeon Credit and Paris Miki), and it is hoped that they can do as well as last spring’s new listings of Hamamatsu Photonics (+50% since listing in March) and Union Tool (+18% since listing in May). Recent OTC listings have been opening at premiums, and this Tuesday’s start of trading in Digi-Cube could bring interest to game software stocks.

Winners and losersThe strongest subsectors last week were Keyence +6.4% vs TOPIX, Cements +5.6%, Secom +4.9%, Precisions +4.7%, Kyocera +4.4%, Blue-Chip Components +4.4%, Electric Steels +4.2%, Construction Macinery +3.4%, Shipping +3.1%, Gas +3.1%, NTT Data +3.0% and TSE Nonbanks +3.0%; the weakest subsectors were Trust Banks -8.2% vs TOPIX, Plant Engineers -5.3%, Real Estate -4.4%, Consumer-Electronic Retailers -3.5%, Apparel -3.0%, Ito-Yokado -2.5%, IBJ -2.4%, MHI -2.3%, TSE Bank Index -2.3% and Major City Banks -2.1%. New ten-year relative highs included Kao, Tires, Consumer Electricals, Blue-

Chip Components and JR East; new relative lows included Spinning Companies, TSE Bank Index and Trust Banks.

Hoya should go higherHoya’s shares rose 15% last week on 3.4 mn shs, its biggest weekly volume in four years, after Q1 consolidated results revealed strong sales growth in 3-4 niche areas and continued cuts in costs. Head count was reduced despite the growth in sales and profits. Hoya also disclosed its consolidated cash flow statement (which will be required by all companies from the Mar 00 term), with Y5.6 bn in free cash flow. The stock should be given a premium for its success in maximizing returns on shareholder assets, and a return to its Aug 97 high of Y6,460 would give it a PER of 35X Fujino-san’s estimates for FY99, about the same rating given to Ricoh and a bit cheaper than Keyence. Local investors such as Tokio M&F Asset Management have started basing their stock-selection on cash flow (as opposed to profits), and JF’s full company reports have been including cash flow statements since spring. Nomura’s transport analyst explained the strong performance of JR East on its generation of positive free cash flow, whereas the private rail stocks are stuck near a 12-year relative low.

Sumitomo Bank’s disclosureSumitomo Bank last week gave investors some more detail about last year’s results. Of last year’s gross profits, 52% came from retail banking, 26% from trading, 10% from international and 9% from wholesale banking. Of the 254.7 bn in unrealized gains on its portfolio of listed shares, almost all (Y249.6 bn) comes from manufacturing companies. It has gains of Y31.6 bn on utilities, Y7.9 bn on services and Y2.3 bn on real-estate shares, but losses of Y23.3 bn on construction, Y7.4 bn on wholesale/retail and Y5.6 bn on financials.

Convenience store bluesThis week’s Ekonomisto carries the laments of five former operators of convenience stores (though none from 7-Eleven), and underscores the risks to new franchisees while suggesting that the royalties charged (65% of gross profits at Family Mart, for example) are exorbitant. Among the complaints: new stores often fail to achieve the daily sales promised by the convenience-store company; even if the sales estimates are achieved, operators are surprised by how much they have to pay out for scrapped products, inventory losses and labor; 15-year contracts make it hard for operators to quit even after they realize they have made a mistake; a former franschisee for Hot Spur said that fewer than 10% of franchisees renew their contracts; Mr Oyama, whose Circle K stores was shut down by the company in a widely reported incident at the end of January, says that almost all franchisees used to come from mon-and-pop owners of rice shops and liquor stores, but that these people now saw little benefit in becoming a franchisee so that now 65-70% of new operators are former salarymen. Even operators of company-owned shops have trouble making ends meet. If investors have been negative on sarakin stocks on the view that their juicy margins are not

sustainable, perhaps they should be more negative on high-margin convenience stores as well.

Bubble sectors languishDespite Mr Obuchi’s promise of a new Y10 tr economic package, the General Contractors underperformed by 1.45% last week; they have underperformed by 31% since their recovery peak in mid-March and now stand only 17% above their 10-year relative lows of January. Real Estates, having formed a double bottom relative to TOPIX in Jul 92 and Nov 94, then outperformed by 50% to their recent peak in mid-Oct 97. Since then they have underperformed by 22% and stand only 10% above their ‘92 and ‘94 lows. Trust banks plummeted to yet another 10-year relative low last week, yet still stand 25% above their Jul 81 low. These poor showings suggest that the market does not believe the LDP’s new reflation policies will be successful.

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