THE ECONOMY: Bullish on Japan
MARTIN, THOMAS J. & Laffer, Arthur B.
Bullish on Japan When share prices catch up to the Japanese economy, the markets should boom BY ARTHUR B. LAFFER AND THOMAS J. MARTIN o w is the time to take advan- equity market, which is...
...And, as such, any global portfolio should overweight Japan by a lot...
...With declining low returns on Japanese assets and high and rising returns on U.S...
...Last month we showed how to use the capitalized economic profits of "USA Inc...
...Also, because the yen will appreciate, creating less favorable terms for Japanese exports, Japanese industries involved in the production and sale of non-traded goods will tend to outperform Japanese industries involved in traded products...
...2. THE DOLLAR-YEN EXCHANGE RATE MIRRORS RELATIVE JAPANESE AND U.S...
...For comparison purposes, the U.S...
...stock market when the yen strengthens relative to the dollar...
...Now, perhaps Japan's worst prime minister of all time is gone and a new start is in the offing...
...I The erosion of asset values has relative to assets in the rest of the world pushed posted land prices down some and to historical asset prices in Japan...
...Figure 3 is a plot of Japan's stock market relative to GDP...
...The Japanese stock and foreign exchange markets went crazy.As I wrote at the time in my paper "Godzdla: The Modern Saga of Japan Takes a Turn for the Better": The Obuchi government has cut taxes...
...In every regard Japan is following the correct fiscal mix to assure a solid foundation for a healthy economic future...
...Pro-growth reforms have actually global enterprises headquar- ciate relative to the yen...
...The Nikkei index, however, is not a 100 percent Japanese portfolio...
...Figure 1 1. THE '90s WERE BRUTAL FOR JAPAN'S MARKET, GREAT FOR U.S...
...This same technique using Japanese capitalized economic 4. THE NIKKEI SHOULD CORRECT UPWARD TO TRACK CAPITALIZED PROFITS OF JAPAN INC...
...40 percent from their peak-and strained the balance sheets of major Japanese banks...
...reminiscent of the Reagan era here in the U.S...
...assets, asset owners try to move their assets out ofJapan and into the U.S.The only way this transfer of assets can occur is by having the Japanese run Japanese GDP is 35 percent higher than it was 12 years ago...
...trade deficit is driven by capital flows), which can happen only if the dollar weakens compared to other currencies, including the yen...
...Today, the Japanese Nikkei index of 225 stocks stands at around 13,500 versus its high in December of 1989 of almost 39,000...
...capital surpluses...
...asset values, investment is on the decline...
...corporate profits by the long-term interest rate...
...Performing even worse, especially in recent years, has 2 been the Japanese small capitalization equity prices, as shown in Figure 2.This should come as no surprise...
...Bullish on Japan When share prices catch up to the Japanese economy, the markets should boom BY ARTHUR B. LAFFER AND THOMAS J. MARTIN o w is the time to take advan- equity market, which is probably more greater trade surpluses (capital deficits) tage ofJapan's depressed stock reflective of actual economic condi- and the U.S...
...The surging Nikkei collapsed (Figure 5...
...to establish the appropriate value of the U.S...
...In our view, Japan could easily be a two-fer, three-fer, or four-fer in the next five years, yet there's no way from here to Sunday that the same could occur in the U.S...
...stock market...
...Japan was in the throes of economic chaos in late 1998 and early 1999.Then new LDP leader Keizo Obuchi cut the highest marginal tax rate on personal income (federal and prefectural combined) from 65 percent to 50 percent, and cut the highest corporate tax from 50 percent to 42 percent...
...Why do we think the new Japanese government may trigger this potential for recovery...
...Japanese assets are very, very cheap tion of an unlikely new prime minister...
...If the Nikkei today had the same relationship relative to capitalized economic profits it had in the first quarter of 1985, and with interest rates and profits as they are today, then the Nikkei today would stand at 46,245, or 3.4 times its level today...
...THE AMERICAN SPECTATOR . June 2001...
...Remember that the Japanese stock market historically has risen relative to the U.S...
...by large amounts and in the right way...
...The easiest way for nomic policy, Japan's political structure is Many of the Nikkei's companies are this to happen is for the dollar to apprefinally in flux...
...We believe Japan is an enormous buying opportunity, especially when juxtaposed against the U.S...
...The most obvious way to profit from the coming prosperity in Japan is to invest in Japanese equities...
...during the 1980s were the direct consequence of Reagan's tax cuts, and higher real interest rates in Japan during the coming decade will also be the dlrect consequence of the resurgence of the Japanese economy...
...There is serious appreciation potential no matter how you slice it...
...In spite of a two-thirds decline in Japanese stock prices since late 1989, 3. AS A PROPORTION OF GDP, JAPANESE EQUITIES ARE HUGELY UNDERVALUED COMPARED TO THE U.S...
...In the course of the recovery, Japanese interest rates should increase...
...GDP is plotted as well.With any reversion to the mean, Japan should be in for an asset market move of historic proportions...
...A darkness spread over the land...
...That said, Figure 4 is very revealing.There is a radical disconnect between stock prices and capitalized edonomic profits starting about 1994...
...Essentially we do this by dividing U.S...
...trade deficit will decline (the U.S...
...Unfortunately for Japan, in early 2000 Crown Princess Masako had a miscarriage and then in April Prime Minister Obuchi had a stroke and died...
...Japan has much more upside potential and far less downside risk...
...According to the Financial Services Agency, Japanese banks carry $1.2 trillion in problem loans on their books, which equates to 22 percent of total lending and 30 percent of GDP...
...He suspended the stock transactions tax, abolished the 1 percent per annum pension fund tax, and set up two commissions to study the implications of a shift from defined benefit plans to defined contribution plans, one for Japanese social security and one for private Japanese pensions...
...You can improve your exposure to the nascent Japanese prosperity by focusing on more domestically oriented Japanese companies...
...That isn't to mention the potential for appreciation of the yen...
...EQUITY PRICES But cheapness in and of itself is no indication of a smart buy.The critical question is the potential for the appreciation of those cheap Japanese assets...
...It has happened before...
...shows the Japanese Nikkei index, as measured in dollars, plotted against L 8 the U.S...
...S&P 500...
...THE AMERICAN SPECTATOR . June 2001 If the Nikkei 225 index had kept pace with the Dow Jones Industrial Average since December of 1989 the Nikkei would be at 145,000 instead of 13,500...
...It was the end to a brief but glorious 5. POUCY MAlTERS: JAPANESE MARKET RISES AND FAUS WlTh CHANGING ADMINISTRATIONS time for Japan...
...With the recent decline in U.S...
...Junichiro Koizumi campaigned as a radical free-market reformer and the voice of change...
...run greater trade deficits market.After years ofbad eco- tions in Japan than the Nikkei 225...
...When the Japanese economy responds, a Japanese small-cap stock portfolio should outperform an overall index like the Nikkei...
...Higher real interest rates in the U.S...
...This increase in interest rates d not reflect higher expected inflation but rather higher expected real returns on Japanese assets...
...This gap between what is and what could be provides Japan with a lot of room to grow...
...Japan's devastating financial collapse, which began in 1989 following decades of unprecedented prosperity, has been truly amazing...
...1 profits and the Nikkei index presents greater challenges...
...stock market as a share of U.S...
...been moved center stage with the elec- tered in Japan...
...The real yen/dollar exchange rate throughout this 12-year period of Japanese demise has mirrored the relative performance of Japanese and U.S...
...A rise back to its previous high of a dozen years ago would produce close to a 200 percent return...
...Asset values incentivize people to save more and consume less...
...With less investment and more saving in the U.S., the U.S...
Vol. 34 • June 2001 • No. 5
