When Do The Parachutes Open?by
First came the Kobe earthquake. Now, it's the Tokyo yen-quake. As the Japanese currency soars to incredible heights against the hapless dollar, the Tokyo stock market is once again taking it on the chin.
Already down 20% this year--and 60% from its 1989 peak--the widely watched Nikkei stock average is nearing the point where the Finance Ministry has traditionally stepped in with massive purchases of shares to pull it back from the brink. With no sign of a rescue package emerging, International Trade & Industry Minister--and former Finance Minister--Ryutaro Hashimoto has even begun calling for a comprehensive plan to "revitalize" the stock market through lower interest rates, trading taxes, and brokerage commissions.
But in the absence of dramatic steps to brake the turbocharged yen, buoy the sagging economy, and boost anemic corporate profits, the Nikkei stock average seems doomed to fall even further. With the Yamaichi Research Institute of Securities & Economics estimating that manufacturers' earnings will fall 1.7% for every one-yen rise in the currency's value against the dollar, most analysts figure the Nikkei could decline an additional 1,500 points, to around 14,000, by summer.
Some even think the average will have to slip below 13,000--back to where it was in 1986--before stocks can again compete with the 3.5% yields on government bonds. Indeed, with Japanese stocks still fetching an average price-earnings ratio of 59, Morgan Stanley & Co. analyst Alexander Kinmont estimates that corporate earnings would have to climb 48% to reflect today's market levels.
As dire forecasts roil the market, bankers, traders, and bureaucrats are quaking over the body blow another huge drop in stock prices might land to the Japanese financial system and overall economy. Because the capital bases of most of the nation's financial institutions are tethered to share prices, the price of merging or bailing out weakened brokerages, banks, and life-insurance companies is bound to rise as the Nikkei erodes (table). In fact, with some banks' capital levels already just a shade over internationally agreed-upon minimums, a costly financial restructuring will help keep credit tight in an economy already handicapped by the strong yen.
BAD NEWS. Economist Robert A. Feldman of Salomon Brothers Inc., for one, sees gross domestic product growth of just 0.2% in 1995 despite earthquake reconstruction efforts and a $12 billion supplemental government spending plan now in the works. That means profits may rise as little as 9% in '95. Consumer spending is flagging, too. "Retail sales have looked terrible," notes Lehman Brothers Inc. economist Andrew Shipley.
The economic bad news is casting a wide pall over Kabutocho, Tokyo's Wall Street. Next month, Japan's top 14 brokerages are expected to announce losses of $2.9 billion for the fiscal year ended Mar. 31--their fourth consecutive deficit. One reason: Goldman, Sachs & Co. analyst David Atkinson estimates that Japan's brokers need to trade $5.8 billion worth of stock daily to break even. But market turnover is running at just $3.4 billion. And while Wall Street and European firms have been ruthlessly cutting costs--Salomon Brothers has reduced its Tokyo staff by 25% since 1990--Japan's brokerages have dragged their heels.
True, local brokers have axed part-timers, farmed out unproductive workers to distant offices, and cracked down on costly late-night drinking sessions in the Ginza. Daiwa Securities Co., where the most recent fiscal year's losses are expected to total $395 million, even moved most of its operations from fancy digs across from the Tokyo Stock Exchange to an unassuming beige building bordering a Shell filling station. But traditions of lifetime employment have kept brokers from slashing payrolls. Atkinson thinks they have 22,200 too many employees.
While big brokers such as Nomura Securities Co., with a capital base of some $20 billion, could lose money for years without running into life-threatening trouble, many other firms are not so fortunate. Take Sanyo Securities Co., which during the bubble-economy years spent $93 million building one of Asia's biggest trading rooms on reclaimed land in Tokyo Bay. Last year, as Sanyo's capital dwindled, the Finance Ministry ordered Nomura and several commercial banks to extend $465 million in aid. But that did not stem the decay. Expected to report a loss of $360 million, Sanyo may now be looking for a suitor. With Nomura struggling to stem its own losses, "maybe a good strong bank will take care of my company," says one Sanyo source.
In fact, Japanese banks may be the salvation of the smaller firms--but they may be the bane of the larger ones. With the Finance Ministry allowing banks to get into trading and underwriting for the first time in postwar history, 16 already have set up securities units, including Daiwa Bank Ltd., which took over troubled Cosmo Securities Inc. last year. How far banks can go to bail out other ailing brokers, of course, will depend in part on how much they will have to absorb on their own books if the Nikkei keeps sliding. If the Nikkei settles at 14,000 by the end of the current fiscal year next Mar. 31, reckons Koyo Ozeki, a analyst with IBCA Ltd. in Tokyo, write-offs on shares could go as high as $50 billion.
RADICAL THEORIES. Analysts are also casting a gimlet eye on life-insurance companies. The industry has long relied on stock-market gains to pay dividends and meet promised returns on policies of 3% to 5%. However, some life insurers, including Chiyoda Mutual and Mitsui Mutual, have come close to depleting their unrealized gains. Worse yet, life insurers are considered to be the leading victims of the $585 billion in foreign exchange losses that Merrill Lynch & Co. economist William Sterling estimates Japanese investors have taken on U.S. Treasuries.
In the face of mounting financial and economic stresses, Bank of Japan Governor Yasuo Matsushita has nudged money-market rates modestly lower in recent days, and many traders expect him to cut the record-low 1.75% discount rate by 50 basis points before long. But Toshimasa Fujii, Japanese country manager for McGraw-Hill Inc.'s MMS International unit, thinks the rising yen will force Matsushita to slash the rate by as much as a full percentage point as early as mid-April.
Perhaps even more radical steps will be needed to pull the market out of its funk. Morgan Stanley's Kinmont, for example, is urging Japan's cash-rich corporations to hike their dividends and form large holding companies to buy back massive quantities of shares. "The only way out is a destruction of equity," he says. If any market is open to radical prescriptions right now, Tokyo is the one.
JAPAN'S WEAK LINKS AS STOCK PRICES TUMBLE
BANKS Lenders already face as much as $11.6 billion in unrealized losses on their portfolios. A Nikkei below 15,000 could mean even more losses and leave capital for some banks, including Long-Term Credit and Daiwa, below internationally agreed upon minimum levels.
BROKERS The top 14 securities houses are expected to post $2.9 billion in losses for the fiscal year ended Mar. 31, their fourth straight annual deficit. With stock-trading volume running 40% below breakeven levels, a shakeout among smaller brokers appears imminent.
LIFE INSURERS As stock losses pile up, insurers are scrambling to meet promised dividend payments and policy returns. Insurers already account for much of the $585 billion in unrealized currency losses that Japanese investors have suffered on U.S. bond purchases.
THE ECONOMY The soaring yen is dashing hopes for a boost from rebuilding the damage of the Kobe quake. GDP growth could remain under 1% this year despite a possible rate cut, an expected $12 billion supplementary budget, and speeded-up public-works outlays.