Just over a year ago, investors would have seen a Japanese stock market that had significantly underperformed global equities for several years, and an economy that was very weak (the Asian crisis had added problems to an already weak economy). Pessimism reigned and global investors were underweighted in Japan. However, there was some cause for optimism: economic recovery from a low base appeared imminent, there was reform of the financial system and within major corporations, and leadership in certain technologies was evident.

Looking back, Japanese equities reached their nadir relative to global equities in the middle of 1998, following a relative collapse that spanned nine years.

Japan Today
In terms of restructuring, there is considerable consolidation occurring among Japan's leading banks, with several two- and three-way mergers announced. Grassroots restructuring of certain better managed companies continues. However, not all companies are participating -- many traditional companies have a management attitude less supportive of shareholders than of other stakeholders. With the pace of change slow and not uniform, there is still much more work to be done in Japan.

In terms of legislative change, it is anticipated that full disclosure of pension underfunding will be required by April, 2001, creating greater transparency and a possible reorganization of cross shareholdings. The new Prime Minister, Mori, is expected to have similar policies to those of Obuchi, and it is likely that he will seek economic growth before tackling the huge fiscal debt problem that has arisen in Japan.

What could be the catalysts for market strength?
There was approximately C$120 billion of foreign buying of Japanese equities in 1999, but foreign investors are no longer significantly underweighted in Japan and foreign buying has slowed. However, investing by individuals is at its highest level in eight years.

There is continued scope for economic recovery based on investment and fiscal spending, although private sector demand has been falling for three years, and broad money growth, at just over 2%, is the slowest since 1994.

The maturation of postal savings of approximately C$15 trillion is under way, and though Japanese Government Bonds may be a favoured home for any money that is not reinvested in postal savings accounts, part of the money flow will likely find its way into Japanese equities.

Leadership in certain technologies, including mobile internet, remains an important catalyst.

Finally, we have seen the first hostile bid for some time (the bid by MAC for Shoei), which, while subsequently unsuccessful, sets a precedent for future corporate activity.

The Economy
Although Japan is technically in a recession, economic conditions are likely to improve slightly this year. Growth in 2000 is expected to build on modest growth in 1999. A modest rebound in earnings from a low base is expected, though the strength of the yen may limit the upside. Medium-term prospects are improving for companies adopting the appropriate rationalization policies (suggesting that stock analysis will be important). The fiscal situation remains very poor, though, and a recent downgrade of Japanese government debt by Moody's may not be the last.

Investment Strategy
What would an appropriate investment strategy be for Japan in 2000? Strategically, the market appears to have good upside potential on the evidence available. However, tactically, certain other regions of the world appear more attractive. Opportunities remain in growth stocks. Deep value stocks are less attractive (still!) -- management attitude is key. The market performed well in 1999 and is currently performing in line with global equity markets. Japan, it may be argued, is a long-term buy, but a short-term hold.

James Clunie is Director of Murray Johnstone International in Glasgow, Scotland