What's Going on in Japan? Is Horiemon's Livedoor to Blame for the Nikkei's 3-Day Tumble? (EWJ, ITF, VPL, JOF, JEQ, INTC, YHOO)

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Includes: AABA, EWJ, INTC, JEQ, JOF, JPXN, VPL
by: Steven Towns

Livedoor Co., a leading Japanese Internet web portal and its maverick President Takafumi Horie (aka Horiemon) are taking a lot of heat for the mass sell-off of Japanese stocks over the past three days. Let's put it this way, the Japanese media is shocked by the widespread coverage by foreign media of the livedoor & Horiemon investigation regarding alleged securities laws violations that is naturally receiving front-page top-story near 24-hour coverage in Japan. The Japanese media has labeled the investigation and subsequent sell-off the "Livedoor shock." Explanations from Japanese securities analysts are varied but a consensus seems to exist that this sell off was overdue but its fast pace was unexpected.

First, let's take a look at the numbers and just how far stocks have fallen. Yesterday the Nikkei 225 Stock Average (proxy ETF: EWJ) lost 462 yen and today it lost 464 yen (-2.94%), but as I was following trading I actually saw it drop as far as 746 yen at one point nearly falling into the upper 14,000s. Consider this, the N225 closed last Friday at a 52-week high of 16,454.95 yen and now sits at 15,341.18. All of this has happened in just three trading days, of which today was cut short by twenty-minutes due to a flood of sell orders that forced the Tokyo Stock Exchange to shut down trading early.

Is it only blue-chip stocks that are tumbling? No, it's every category of stock. The broader TOPIX (sub-index tracking ETF: ITF) has fallen in-line with the N225, as has the tech-heavy JASDAQ and the MOTHERS Index for start-ups (where livedoor and its subsidiaries are traded). The only positive news for stocks if you want to be optimistic, is the yen losing a few points to the dollar, but honestly, this factor was most likely overlooked as investors and traders were pre-occupied with exiting positions.

So then, what exactly is going on in Japan and are livedoor and Horiemon to blame? I will answer both questions together. Japanese stocks are undergoing a correction sparked by the Livedoor-Horiemon investigation.

Livedoor itself is a tiny insignificant company by market-cap size (prior to the investigation it had a market cap of slightly over US$6 billion and since has lost at least US$1 billion of that as trading of its shares are halted due to overwhelming sell orders) when compared to the rest of the fish in the sea. The big fear for individual investors surrounding livedoor's investigation is the fact that it might not be the only "growth" designated MOTHERS traded company out there that has used stock splits and other means of inflating financials and stock prices. Essentially the investigation could open a can of worms. I find this somewhat unlikely but wouldn't be surprised if news were to come out of another firm or two guilty of such practices.

The concern for investors surrounding the investigation of Horiemon is that his strategy of growth by M&A might be frowned upon even more than it has in the past and also bring rise to the questioning of hostile takeovers even in cases when individual shareholders would benefit. Horiemon is basically hated by the establishment in Japan and his company's admission into the Nippon Keidanren (Japan Business Foundation) has been called a "mistake" and "premature" by Keidanren's president who expressed his feelings in a press conference today. Lastly, the Tokyo Stock Exchange may be force to take action and delist livedoor's shares from the exchange. Some might remember Kanebo and Seibu Railway were delisted for similar reasons to those behind livedoor's investigation in 2005 and 2004 respectively.

At any rate, some analysts are calling the three-day Japanese stocks decline an "overdue" correction after the TOPIX Index and N225 both gained upwards of 40% in 2005. Mid- and smaller-cap stocks performed even better. The total drop over the past three-days by the N225 totals 1,113.77 yen or a loss of 6.8%. Considering the significant gains experienced last year, a 6.8% correction is nothing much to get over-excited about or spooked by.

Another factor exists that prompted today's back-to-back 460+ yen sell-off. The "disappointing" earnings reports by Intel (INTC) and Yahoo (YHOO). The negative reaction by Wall Street to these firms' earnings brought concern to Japan as its leading IT and semiconductor firms were sold off putting heavy downward pressure on indices.

With the above mentioned 6.8% correction in Japanese stocks what's the individual investor or newbie to Japan investing to do? I will provide my thoughts and analysis in a follow-up post today so be sure to check back.

Those interested in reading more about Horiemon and livedoor should refer to these earlier posts:

Livedoor’s Shares Tank 14+% as Horiemon and Livedoor Co Suffer in Stock Scheme Investigation — Open the Flood Gates (EWJ, ITF, VPL)

Livedoor’s President/CEO “Horiemon�? Tearfully Rejects Offering Dividends at Shareholder Meeting

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