Polarization Creates Clear Winners and Losers In Japan's Recovery Tide

Despite investor doubts about not only the Bank of Japan’s, but also Prime Minister Shinzo Abe's administration’s competence to engineer a lasting recovery in Japan, we believe that Japan’s economy and corporate sector are already in a solid secular recovery that will survive any interim cyclical downturns.

As TJI predicted in August 2004 (The Next Izanagi Keiki? Japan’s Recovery Looks Built to Last), the current recovery is the longest in Japan’s post-war history. However, the most striking feature of this recovery is "polarization". A rapidly aging population, globalization and growing competition from Asian neighbors is creating clear winners and losers in terms of regions, local population growth, real estate prices, regional banks, industrial sectors and individual companies.

In short, the rising recovery tide will not lift all boats. There is significant consolidation and reorganization through M&A underway in many sectors. Nomura Securities has identified 18 industry sectors out of a total 136 where the potential for consolidation is particularly high, including electric/electronic trading companies, medium-sized construction companies, electrical facilities construction, textile trading companies, other paper/pulp and consumer finance.

Thus investors need to discriminate companies. For example, no less than 42 companies listed on the Tokyo Stock Exchange and JASDAQ have special notes in their financial statements regarding bankruptcy risk.

While most of these are little known to foreign investors, the list includes Sanyo Electric (SANYY), Hitachi Zosen and Mitsubishi Motors, where break-up value and the large pool of risk capital searching for M&A, MBO and other financing opportunities is the main factor supporting individual stock prices, while the group as a whole is down 47% over the last year.

Meanwhile, stocks like Nintendo (NTDOY.PK) are thriving, and the Nikkei 225 has renewed a 6 1/2-year high on the highest trading value in seven months and signs that individual investors hurt by the sell-off in junior markets in 2006 have recovered and are again actively trading stocks.

Disclosure: Author has no position in above-mentioned stocks.