City: Tokyo tremors threaten the West

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The Independent Online
IT'S NOT often you come across a contrast as stark as this one. Shares in Mitsubishi, one of Japan's largest banks, stand on a price/earnings ratio of 68 and yield less than half a per cent. Barclays, smaller than Mitsubishi but in much the same league, is on a prospective multiple of 14 and yields 9.4 per cent. If there's any logic at all in these valuations, they suggest that Mitsubishi should be by far the better long-term performer of the two. Investors are prepared to pay more for Mitsubishi because in the long run they expect it to be better value.

That's what the textbooks tell you, anyway. The reality is a whole lot different and is one of the reasons why Japanese equity strategists like Tetsuo Tsukimura of Smith Barney and Neil Mackinnon of Yamaichi think the 60 per cent plus collapse in Japanese share prices since their peak in December 1989 is just the beginning. According to Mr Tsukimura, Japanese equities should be about half their present level.

On any fundamental analysis, nobody in their right mind would rate Mitsubishi a better bank with better prospects. Barclays has just declared bad debt provisions of pounds 1bn for the first half of this year; its profits have been wiped out by the recession; its profligate lending decisions have made it a laughing stock in the City; and like all the high-street clearers, its name is dirt among the British public.

But for all that, its problems pale into insignificance when set against those of the Japanese banks. Compared to them, Barclays is a model of prudent, user-friendly, efficient and well-regulated banking.

Maxwell, Brent Walker, Canary Wharf and all the other corporate failures the British banking system has been associated with over the past five years amount to a pretty impressive catalogue of catastrophes.

But they are as nothing compared with what the Japanese banking system is having to cope with. Japanese banks are facing bad debts potentially as high as Y56,000bn ( pounds 231bn). Admittedly, Mitsubishi is one of the better ones, with a relatively low exposure to the speculative boom of the 1980s. Unlike a number of its Japanese peers, it will survive. Even so, its problems are huge and daunting, an Everest of a mess to sort out against the Mont Blanc faced by Barclays.

Mitsubishi's reported profits have so far taken little or no account of the massive build-up of bad debt incurred by Japanese banks in the property market and other areas of the domestic economy. On any international comparison, its capital ratios are shot to bits. So why do Mitsubishi shares continue to attract a higher rating than those of Barclays? Isn't Mr Tsukimura right in arguing that despite the headlong plunge in Japanese equity prices over the last two years, the Nikkei is still fundamentally overvalued?

IF HE is right, and Japanese equities are heading for Western-style valuations, you can expect to see the Nikkei fall to between 6,000 and 8,000. That might be a better reflection of the underlying reality. But for the Japanese financial system, the Japanese domestic economy and perhaps the world economy too, it would spell disaster. It also helps explain the panic series of measures announced last week by the Japanese ministry of finance to restore confidence in the economy and banking system and so indirectly support share prices.

For the time being they seem to have worked. Over the past week, the Nikkei has rebounded by more than 13 per cent. It was as if the authorities had decided that 15,000 was the level at which they had to do something. Once the Nikkei showed serious signs of falling through this floor, the government knew it had to act. Too much was at stake. With the capital base of Japanese banks heavily reliant on the value of the Japanese stock market, a further collapse would have threatened the whole fabric of the financial system. Unlike Britain, Japan can still afford to buy its way out of trouble, but whether the measures are enough is open to doubt. Too little, too late is the view of the super bears like Mr MacKinnon.

Even if you believe the Japanese economy will continue to grow through the 1990s, one thing is certain: it's not going to do so by very much. The spectacular growth of the '60s, '70s and '80s is a thing of the past. In any case, Japan shows all the classic symptoms of sinking into recession. Consumption and investment are weakening and growth in both exports and housing starts is beginning to falter. Last week it was announced that real household expenditure in June fell by 3.2 per cent compared with the same month last year. Corporate earnings are now in their third year of decline, with every possibility that the trend will continue into 1993 despite belated attempts to address labour and other costs. Just how much does it take before investors realise that corporate Japan isn't all it was once cracked up to be, that perhaps the Japanese stock market doesn't deserve the premium it continues to enjoy over Wall Street and London?

Professional Japanese investors begun to suspect it a while back. They haven't been buyers of Japanese equities for a long time. Foreigners, including the British, have proved a lot more difficult to convince. They have been buying the market the whole way down from its peak. Over the past year alone, foreign investors have sunk perhaps as much as dollars 50bn into Japanese equities. It's not just their fingers that are burnt: it's their arms and bodies as well.

They seem to have been the last to get the message; at best, Japanese growth is slowing to European rates and can no longer sustain the sort of premium valuation the Nikkei has enjoyed for the past 10 years. Even now they are reluctant to accept it. Nick Knight is telling London clients of Nomura to pile back in or miss the chance. He believes the Japanese authorities have drawn a line in the sand at 15,000, which they intend to defend whatever the cost. If the latest package of measures proves insufficient, they'll pump even more money into the economy, Mr Knight believes. They can afford it, after all. They'll do as much as it takes for as long as it takes to support the financial system and prevent the Japanese economy slipping into recession, he says.

Let's hope he's right. If the Nikkei really is heading for 6,000, the implications are dramatic. The standard Western view is that Japanese banks are already out of the international lending market, so meltdown in Tokyo won't matter very much outside the domestic Japanese economy. The same would be true of deep recession in Japan, the argument goes. Since the West doesn't export a great deal to Japan, it won't have much impact on Western economies.

Don't you believe it. With the Nikkei at 6,000 there would be massive repatriation of Japanese investments overseas. With no home market to sell to, Japanese manufacturers would be forced to resort to desperation measures in export markets, possibly triggering a return to the protectionism and trade wars of the 1930s. Worldwide recession would turn into slump. No wonder the Japanese authorities are determined to stop any further slide in the stock market.

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