After exploring further gloomy prospects for the US housing sector, CLSA’s Christopher Wood and his newsletter Greed & Fear land in Japan this week and conclude that, unlike the Americans, the Japanese “need no lessons in regulating financial excesses”.

The legacy of Japan’s 1980s Bubble era not only means lingering risk aversion amongst the population at large, notes Wood, “It also means healthy, if sometimes too healthy, distrust for financial spivvery.”

It also explains why the Bank of Japan has been worrying in recent years about renewed asset bubbles and why the BoJ is uncomfortable with the distortions posed by the now seemingly unwinding yen carry trade, he adds.

Japan is primarily an export-driven economy. This is why the BoJ refrained from raising interest rates this month in spite of BoJ governor Fukui’s desire to lift the overnight call rate to 1 per cent by the time of his retirement next March. As for the September policy board meeting, the central bank will “wait and see” in the intervening weeks what happens to the now still escalating credit unwind.

Wood’s view is that the BoJ should raise rates regardless of what is happening in the US economy. “But that stance is most unlikely to be adopted, particularly as the BoJ has plenty of experience of house-price declines turning nasty. It will be hard for Fukui to raise rates unless he takes a risk and acts specifically in the cause of normalisation.”

At least, notes Wood, the humiliation of Prime Minister Shinzo Abe and his ruling LDP in the recent election for the Upper House of Japan’s parliament “has had the positive effect of making Japanese politics more interesting”. The opposition DPJ will now seek to block LDP legislation in the Upper House, creating the likelihood for a general election within the next several months, he says, noting: “Greed & Fear views elections in Japan as a potential positive catalyst.”

Japan’s recent economic recovery has taken place despite drastic fiscal consolidation introduced by the Koizumi government, notes Wood. The economy has performed relatively impressively given the fiscal austerity and the fact that income growth has been all but stagnant. The question now, according to Wood, is “whether this fiscal austerity will be maintained if the worst happens and America enters recession.”

On where the astute investor should go in Japan, Wood says:

Japan’s construction sector has little downside and is a potential beneficiary from the likelihood of a decelerating Japanese economy in coming months. By contrast, property has been the one area in Japan geared into the global credit bubble. Greed & Fear’s view is that that game has for now peaked with the unwinding of the credit bubble. Asset values are likely to go down before they go up again.

The lack of an interest rate hike in Japan has clearly hurt the banks. But Japanese mega banks do not appear to have significant exposure to structured finance. The reason for this seeming lack of exposure is a combination of risk aversion and regulatory oversight. Japanese mega banks are at present without earnings drivers. They are, however, liquid as stocks, which is why they can be easily sold down.

Japanese trading companies have done well in recent years as commodity plays. But they are much more emerging-market plays than narrow commodity plays. There is long-term scope for the rerating of trading companies to continue. There is also the potential for significant releveraging for these companies.

This entry was posted by Gwen Robinson on Friday, August 31st, 2007 at 13:15 and is filed under Capital markets. Tagged with bank of japan. Edit this entry.