Outlook: Wall Street threatens Japanese dawn

THOSE THAT recommended caution on equity markets this year, which unfortunately includes this column, have so far been proved dramatically incorrect. This is shaping up to be one of the best-ever bull years for worldwide equities. From the big daddy of Wall Street down to the minnows of Morocco and Mongolia, it is a year of unparalleled optimism. Even in Europe, whose stock markets are among the laggards so far, we've seen a rise in leading stock values of around 15 per cent on average.

However, it is one market in particular which is tilting the balance. After years in the doldrums, the Nikkei is storming ahead, up a staggering 34 per cent in local currency terms since the beginning of the year. A visitor from Mars might reasonably think the strength of this recovery, together with the accompanying rise in the value of the yen, can be explained by looking ahead to corporate restructuring and economic growth. Alas, he would be wrong.

Japan's stock market revival is being fuelled largely by foreign investors, and particularly those from the US and Europe. Tokyo Stock Exchange figures show net foreign purchases reached a record 4.8 trillion yen in the first half of 1999, suggesting the full-year total will easily outstrip the 5.6 trillion yen peak in 1991. Taking this massive inflow alongside the continuing distress repatriation of funds by Japanese institutions, it is not surprising the Bank of Japan has had to take steps to prevent a substantial appreciation of the yen. The surprise must be that it has achieved this with foreign exchange intervention as low as the rumoured $25bn.

Yet it is a real leap of faith on the part of those foreign fund managers to invest on the basis of long-term recovery in the Japanese economy. There is scant evidence of anything more than stabilisation of the decline, and even the government has said that might not last without yet another budget stimulus. Japan-watchers are united in the belief that the corporate and banking sectors have scarcely embarked on the necessary restructuring.

Overseas investors have also been returning to the South-east Asian markets, whose rebounds have taken even the most optimistic analysts by surprise. There is even less reason in these instances to believe that the structural reforms said to be needed in the wake of the global financial crisis are in place. Rather, the money that flooded out during the panic is sloshing back in.

The reason for the flow of liquidity to the east is a growing belief that share prices in the US have become just simply too expensive, combined with a reluctance to pile into European markets until the euro has proved that it is not a fatally weak currency.

To understand how superficial the revival in the Tokyo market really is, look no further than where the money is going - generally not into cyclical stocks or those geared to wider economic revival, but into hi- tech, Internet and computer stocks. In this sense the renewed Japanese stock market boom has become just an extension of the technology fever that grips Wall Street.

The trouble with market rallies based on such flows is that they can go into dramatic reverse, as the Asian countries know only too well. Even more worrying is the possibility a self-fulfiling collapse on Wall Street dries up the tide altogether.