The cyclical upturn in Japan will be confirmed by the statistics published over the coming quarter. Worries over the financial crisis have faded away in line with the stock market appreciation. A strong recovery in the corporate earnings should help global investors to regain confidence over the investment in Japan. We think the TOPIX (Tokyo Price Index) has a potential to reach 1,350 from current 1,100 by the end of this year, a 20 percent upside. Valuations are lower in terms of both an historical and a global comparison and as such the downside risk seems to be limited. The Clariden Japan Equity Fund offers an attractive investment opportunity.

Recent economic figures have begun to demonstrate signs of a recovery. Led by positive export growth (+7.6 percent in 1Q), industrial production started to show positive monthly growth numbers from February. The increase in shipments, led by exports, and modest production growth in April resulted in an acceleration of inventory adjustment. We expect the up trend in industrial production – which has a high correlation with the stock market – to continue.

While the evidence of a cyclical upturn has become more apparent, rising unemployment rates, weak consumption and corporate capital expenditure remain major concerns. The unemployment rate (5.2 percent in March) is expected to remain high, due to ongoing corporate restructurings. The change in corporate behavior in particular the loosening of the traditional “life-long employment model” is a long-term positive factor for the Japanese economy, because it will create a more flexible labor market.

The short-term disadvantage is the negative impact on consumer spending. One should keep in mind that consumer spending, the unemployment rate and level of corporate investment are all lagging economic indicators. They are expected to stabilize as the economic recovery takes hold later this year. However, an export driven cyclical recovery, on the other hand, poses a major risk that a slower than expected global economic recovery will damage Japan as well.

Strength in the yen will likely continue in the near term. The difference between short term real interest rates of US and Japan have been on the narrowing trend since last year, signalizing a further strengthening of Japanese currency, which could reach 120 per dollar in coming months.

According to survey data, the break-even currency rate for Japanese exporters is currently around 115 per dollar. This suggests that a JPY/USD rate of around 120 is acceptable, even though a stronger yen will negatively affect export industries such as automobiles and electronics.

In the long run, we believe that yen will lose value against USD again, reflecting the longer-term weak fundamentals of the Japanese economy.

In the light of the improving economy, fears over the financial crisis have softened. Large bankruptcies look unlikely to happen in near future and as a result, banks will gain time to improve their balance sheets. With the crisis now receding, one risk scenario which was widely discussed at the beginning of the year, the nationalization of banks, seems less likely in a period of an economic recovery.

The corporate earnings are expected to grow sharply in FY2002. Aggregate recurring earnings of the 1,535 companies listed on the Japanese stock exchanges are expected to increase 96 percent in FY2002, as burdens from non-operating expenses decline and as restructuring efforts being to show through in the earnings numbers.

Aggregate sales are expected to grow modestly by 1.3 percent. The risk of downward earnings revision remains, and would become more pressing if the yen were to appreciate further or if the global economic recovery was delayed.

However, even discounting the fact that those “bottom-up” estimates, which are produced by the companies themselves, tend to be more optimistic than “top-down strategy” estimates, we believe that net income should recover in value to the level of FY2000, at least for the industrial sectors excluding banks. The V-shaped earnings recovery will support stock market performance.

The sharp recovery in FY2002 earnings has lowered the valuation of the Japanese stocks to an attractive level both in terms of an historical and a global comparison. The price earnings ratio (PER) for the whole market is expected to be 25X in FY2002, which is in line with that of the UK and Germany and much lower than the PER 1998 of 72X in Japan, during the last trough. On the basis of both the price cash flow ratio (PCFR) or the price to book ratio (PBR), Japan looks much more attractive than other countries. Valuations are low relative to other markets because investors are still underweight in Japan. This suggests that the Japanese market has a large upside potential, once investors become more confident about the market outlook. This we expect to happen as the V-shaped earning recovery become more apparent later this year. We think the TOPIX has the potential to reach 1,350 by the end of this year from current 1,100, a 20 percent upside.

Japan already has outperformed the world index by 20 percent in dollar terms since the beginning of the year. Some expect the excitement to subside when the World Cup is over. We do not agree with this opinion, because the positive stock performance will continue to be supported by the cyclical upturn of Japanese economy. Statistically, Japan has gone through 12 economic upswings since 1952 and their average duration is 34 months. We believe that the bull market will continue — at least for the rest of the year.

Our benchmark TOPIX, which includes all 1,498 companies listed on the 1st section of the Tokyo stock exchange, consists of 33 sectors. Our favorite sectors are machineries, electronics components and consumer electronics sectors because of their world competitive products. We believe that consumer spending, one of the lagging indicators, will improve later this year. We will continue to focus on domestic-oriented sectors such as services, retailing and leisure sectors. In addition, the recent trend of a strong yen favors these non-exporting sectors.

As for the banking sector, we remain slightly underweight due to its weak fundamentals, even though we think the worst of the Japanese banking crisis is over now.

We believe that, as long-term oriented investors, companies with competitive products, superior management and sound financial situation are going to win in the survival game. We will continue to focus on the winners of the each sector, which have reasonable valuations.

Japan is offering an attractive return prospect relative to other global stock markets. Investing in Japan through the Clariden Japan Equity Fund is one of the best ways to participate in its attractive upside potential.

(This article is contributed by Clariden Bank, London, which is a wholly-owned subsidiary of Credit Suisse, Zurich, specializing in asset and client relationship management)