No. 17 — April 28, 2000


Weekly Review

--- by Jon Choy

For seven days beginning April 14, investors around the globe were reminded that what goes up must come down. That day, high-flying U.S. equity markets felt the force of gravity with a vengeance. The three key indexes suffered record-breaking single-day point losses as waves of sell orders sent all types of stocks south. True to form, once American markets caught the "bug," Asian markets "sneezed" on their first subsequent day of trading, with national stock market indexes across the region registering big declines April 17. Although the volatility of Japan's stock markets was amplified by a structural factor, observers warned that investors there were in for a bumpy ride. Ongoing changes in the nation's financial services sector and business world are opening up new investment opportunities while, at the same time, exposing stock prices to a broader spectrum of influences.

American investors infatuated with high technology stocks have driven their share prices to astronomical levels as measured by such traditional yardsticks as price/earnings ratios. Blue-chip issues also have enjoyed active trading from the overflow of investor enthusiasm. By the start of April, the price gains had reached the point where the word "overvalued" had become commonplace in analysts' opinions. Washington then reported that a key gauge of inflation had jumped much more than expected, and investors' jitters quickly turned into a selling panic. When the closing bell mercifully rang April 14, the sell-off had chopped 9.7 percent (355.49 points) from the Nasdaq, 5.8 percent (83.95 points) from the Standard & Poor's 500 index and 5.7 percent (617.18 points) from the Dow Jones Industrial Average. Investors around the world waited nervously over the weekend, wondering whether U.S. stock prices had hit bottom or would go into another free-fall.

Given time-zone differences, Asian markets began and ended trading April 17 without the benefit of an answer to this critical question. The uncertainty was telling, though, as market indexes around the region sank like stones. Hong Kong's Hang Seng shed 1,380.30 points or 8.44 percent of its value. Traders in Seoul drove down the Korea Composite stock index by 11.63 percent, while Singapore's Straits Times index was off 8.69 percent, Malaysia's benchmark indicator was behind 6.04 percent and Thai shares fell 5.2 percent. Only the Taiwan Stock Exchange weighted index bucked the downward trend by logging a 1.42 percent advance for the day, as bargain hunters rushed to pick up shares in the wake of the previous week's 12.44 percent fall.

As measured by the Nikkei 225, equities listed on the first section of the Tokyo Stock Exchange had lost an average of 6.98 percent of their value by the close of trading April 17 (see Figure). This 1,426.04-point drop was the index's fifth-largest fall — a ranking that would have been higher had trading halted at the day's low point, when the benchmark Nikkei was more than 1,800 points off its start.

Adding to the selling pressures in Japan was the plan that TSE authorities had announced April 15 to change the mix of first-section companies included in the Nikkei 225. Investors hastily reconfigured their portfolios to match the new index, adding to the market's volatility.

Effective April 24, TSE officials said, 30 issues that made up the Nikkei 225 would be replaced based on a new selection methodology. Instead of comparing a stock's 10-year history of turnover and price fluctuations to fixed benchmarks, the TSE would select the most liquid 450 shares from the exchange's first section, segregate them into six sectors — technology, finance, consumption, materials, capital goods and other, and transportation/public utilities — and then choose 225 stocks by considering the balance among the six sectors. The 75 stocks with the highest liquidity automatically would qualify for inclusion. This would mean, according to TSE calculations, that such companies as Fuji Spinning Co., Ltd. and Nippon Carbide Industries Co., Ltd. would be dropped in favor of the likes of NTT DoCoMo, Inc., Kyocera Corp. and Seven-Eleven Japan Co., Ltd.

Trading was fast and furious during the week of April 17. Investors first dumped the shares of firms slated to be dropped from the Nikkei 225 and then bought the stocks that would be included. Not surprisingly, the prices of the issues being added to the index were much higher than those being deleted. Thus, investors either had to put more money into the market or sell additional shares of lower-priced stocks to buy fewer, more expensive shares of incoming stocks.

Thus, while the Nasdaq, S&P 500 and DJIA were recovering — if only partially — from their steep losses, Japanese shares faced relentless sell-off pressures. The adjustment process peaked April 21, when the Nikkei 225 fell 706.64 points or 3.73 percent. Although the index rebounded 227.47 points April 24 to end at 18,480.15, this close still was far off the recent high of 20,833.21 recorded April 12.

The market's fall sent coalition government politicians scurrying. Liberal Democratic Party, New Komeito and New Conservative Party members quickly — reflexively, some analysts would say — assembled a plan for Tokyo to pump more than ¥1 trillion ($9.1 billion at ¥110=$1.00) into TSE stocks to halt the market's decline and stabilize prices.

During the 1990s, traders periodically suspected that the government was engaged in what they derisively called "price-keeping operations" — shorthand for managers of various Ministry of Finance and Ministry of Health and Welfare trust funds using money at their disposal to buy stocks to prop up drooping prices. While these moves might have impacted prices at the margin, they could not reverse the market's general decline. This time, moreover, coalition government politicians also wanted Tokyo to accelerate the public works spending planned for FY 2000 to help counteract the Nikkei's tumble.

Although some officials indicated that they would study the price-keeping operation suggestion, Prime Minister Yoshiro Mori and Finance Minister Kiichi Miyazawa quickly threw cold water on the idea, arguing that experience had proved such efforts to be ineffective. Echoing the thinking of any number of outsiders, Management and Coordination Agency head Kunihiro Tsuzuki told reporters that Tokyo should not be involved in the stock market. Nevertheless, the government agreed to keep close tabs on the situation and to prepare contingency plans. So much for its advocacy of the market mechanism, cynics would say.

Legislation recently approved by the cabinet that would create new protections for buyers of financial products inadvertently has added to the skepticism about Japan's commitment to market forces. The bill would require firms to provide clear and complete details about any publicly sold financial instrument, including information about the degree of risk. It also would establish penalties for noncompliance with the reporting rules and would force firms to reimburse investors for any losses incurred on products that failed to meet the disclosure requirements. However, like their American counterparts, individual investors in Japan no doubt will learn firsthand that what goes up in the stock market can go down, the government's good intentions notwithstanding.

The views expressed in this report are those of the author
and do not necessarily represent those of the Japan Economic Institute

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