One reason is that they had been beaten down so far. In a world awash in cheap money seeking high returns, some was bound to wash up in Germany and Japan. The German DAX index has soared some 85 percent from its low in March 2003, but European shares are still cheaper than American ones. The Nikkei index is up 30 percent in the same period, and it, too, is cheap compared with New York markets.
But here the paths diverge. Although Germany still has some upside, its economic recovery has no traction, and the markets are expected to top out pretty soon. The Japanese economy, on the other hand, is taking on a healthier glow. Despite three false recoveries in a decade, economists believe it might be real this time. Japan–the original “sick man” of the rich world–is, of all places, now the hot place to be.
Industrial production and domestic demand are both stronger than in the Eurozone, notes Goldman Sachs chief economist Jim O’Neill. Confidence is up, prices are falling at a much slower rate and pockets of the economy show the first shoots of inflation. “We are watching Japan very closely,” says David Bowers, global equity strategist for Merrill Lynch in London. “Europe is just a bystander.”
Positive economic news has tumbled out of Tokyo in recent weeks, from machinery orders to retail sales. Michael Hughes, chief investment strategist of Baring Asset Management in London, cites further reasons for optimism. The Japanese population in the key spending age of 35 to 55 is finally growing again. Corporations have restructured their balance sheets and now generate cash worth 10 percent of GDP. Hughes’s Boston headquarters even distributed a press release last week announcing its optimism: “We’ve all waited about 13 years for Japan, so when it does happen, people get fairly excited about it.”
With data now showing that Tokyo land prices may have bottomed out, shares in property developers like Mitsubishi Estate are bouncing back. Bernard Horn, manager of the $29 billion Polaris Global Value Fund, finds some healthy cash flow among the “stodgy, boring companies that haven’t moved,” such as those dealing with building materials, finance and utilities. “Not all the factories in the whole world are going to be in China,” says Horn.
Europe’s little run is not quite over yet. Morgan Stanley strategist Teun Draaisma calculates that the average dividend yield in Europe was 2.8 percent in January, well above the 1.6 percent average in the United States. Deutsche Bank equity strategist James Barty notes that European stocks are cheap relative to their history, trading at 13.5 times their projected 2004 earnings, when the average is 15. “The market has another 10 to 15 percent to go,” says Barty.
But the consensus is that Germany’s recovery has weaker legs than Japan’s. Prime Minister Gerhard Schroder’s watered-down economic reforms won’t put a dent in the 11 percent unemployment rate. The strong euro is starting to bite into export sales. And fund managers now buy German stocks despite the Germany story, not because of it. Matt Pickering, a manager of European equities for Institutional Capital in Chicago, picks German companies only if they measure up well against global rivals. He likes, for example, German chemical giant BASF, trading at about 14 times earnings, because it looks cheap compared with U.S. rivals DuPont and Dow Chemical, which are closer to 21 times.
Bowers goes so far as to argue that the global economy hinges on Japan. Watch what Japanese companies are going to do next with their free cash flow, he says, because if they pump it into domestic investment, there will be less money for the Bank of Japan to buy U.S. Treasuries, and thereby fund the U.S. deficit. “We are all so obsessed with China and the U.S. and what Greenspan says, but Japan is the one in a position to call the shots,” he says. That’s a place in the world Japan has not been in, in more than 13 years.
