Can markets defeat global uncertainty?

Caution to prevail as Japan, U.S. pick up steam, Barron's chief says

by Takashi Kitazume

With the Saddam Hussein regime effectively ousted, the world is a lot less jittery than when the U.S.-led war in Iraq began, but that doesn’t mean clear skies for the global economy, according to Edwin A. Finn Jr., editor and president of Barron’s magazine.

Stock markets around the world are now about 10 percent higher than immediately before the war started, but the rally hasn’t been a robust one, and some markets — including Tokyo’s — have been faltering in recent days, Finn said at a seminar Wednesday organized by the Keizai Koho Center at Keidanren Kaikan in Tokyo.

“This is because markets are always forward-looking, not backward-looking,” Finn said. “The market is looking right now to what would happen tomorrow, and next week, and next month, and next year — not what happened last week with the war.”

The economies of Japan and the United States are inextricably intertwined, but with one dependent on the other — and neither in good shape — investors are becoming increasingly worried about the risks the world’s largest and second-largest economies are posing to the world economy.

In the United States, consumer spending is showing signs of slowing down while business executives — still reeling from the aftereffects of Enron, WorldCom and other huge corporate scandals — are being cautious about new projects, Finn said.

The hangover from the late 1990s stock market boom has been particularly painful for telecommunications and technology, he said. Given the tendency by U.S. managers today to severely assess the cost-performance of any new investment, “I would advise you not to expect the technology sector to return to its glory days anytime soon,” Finn said.

In Japan, much remains to be done on both the political and the business fronts, especially regarding structural reform of the economy. The outbreak of the deadly SARS virus, meanwhile, is threatening to have a debilitating effect on other East Asian economies for several months, Finn said.

So what do these developments add up to in terms of economic growth for the U.S. and Japan?

Finn forecast that the U.S. economy will grow between 2 percent and 2.5 percent this year — and about the same pace next year — “even if President (George W.) Bush succeeds in turning his war dividend into a tax cut.”

Bush’s tax cut package is getting mixed reactions at home, and many economists, including Federal Reserve Board Chairman Alan Greenspan himself, have expressed concern that its large size will lead to even more disturbing budget deficits in the future.

The U.S. government reportedly expects to set a record budget gap of over $300 billion this fiscal year, assuming Congress passes President George W. Bush’s latest tax-cut plan, which doesn’t account for the cost of bombing and rebuilding Iraq.

“Budget deficits lead to weaker currencies, and that will add problems for Japan and many other countries” that rely heavily on exports to the U.S. market, he added.

In the meantime, Finn forecast that economic growth in Japan will crawl along somewhere between zero and 1 percent for the next few years.

While the gradual improvement predicted for the U.S. economy will be a positive factor for Japan, “Japan has to do more than wait for the U.S. economy to rebound,” he warned. “It has to work on political and economic reforms. There has been some progress in this area . . . but I would suggest that more aggressiveness is needed.”

On the business front, Finn said Japanese companies need to do more than just adopt U.S. business models or lay off workers at unproductive factories. Some should institute wholesale changes in management, he said.

Citing Nissan Motor Co.’s revival under the leadership of Carlos Ghosn, Finn said the difference between Ghosn and the top Japanese executives that ran Nissan before he came on board was not management knowledge but “the will” to turn things around. “Some difficult decisions will have to be made if Japan is to have the economic vitality that it deserves,” he noted.

The reforms in the financial sector have also been insufficient, he said, noting that “tens of thousands of jobs will have to be eliminated and hundreds of billions of dollars of debts must be written off” before Japan can bounce back.

Turning to the stock markets, Finn said the U.S. looks like it is “at the beginning of a nice move upward,” but added that it would rise in starts and stops over the next few months.

Finn said that if terrorism can be prevented, the stock market will concentrate on corporate fundamentals, which “do not look so bad.” Assuming U.S. corporate earnings after cost-cutting and other efforts rise roughly 10 percent this year and about the same amount next year, “I would expect the stock market to rise 10 percent a year for the next few years,” he said.

Finn also forecast that the Dow, now at 8,337.65, could regain 10,000 within a few years or even a year from now.

Finn said the bear market has taught American investors many important lessons that will lead to greater stability in the years ahead.

Americans will invest more in stocks that bring in sure dividends, instead of the high-flying tech issues that led to the irrationally exuberant stock bubble, he said. They will also opt for more balanced investment strategies that make use of bonds as well as stocks.

Finn also predicted that American investors would put more money into blue chips than tech stocks.

“Over the next five years, half the technology stocks will in fact double or triple in value,” he said, “but the other half will go out of business . . . People investing in the technology sector need to be more selective than in the past.”

On the positive side, Finn said that despite the sluggish growth forecast for Japan, the Tokyo stock market “looks like it is at or near a bottom,” adding that American interest in Japanese stocks is also rising.

As an example, he cited the recent move by the California Public Employees’ Retirement System (Calpers), the largest U.S. public pension fund, to up Japanese investment activity by about $200 million through a $1 billion stock fund being formed by W.L. Ross & Co. and Taiyo Pacific Partners LLC.

“American investors are also looking at small and medium-size companies in Japan, which can benefit by modern technology, modern management techniques and become world leaders,” Finn said. “Right now their stocks are unduly depressed, and you will see more takeovers, mergers and acquisitions . . . than ever before, he said.