Is Tokyo's Bull Riding Too High?

By Gordon Bock

Nomura and Japan's other giant securities firms have harvested huge profits from a bull market that has raged on the trading floor of the Tokyo Stock Exchange for six years. The Japanese call it the age soba, or rising market, ascent has been dizzying: the 225-stock Nikkei index -- Japan's equivalent Dow Jones industrial average -- has surged 400% in value since beginning its bullish burst. The $3.5 trillion now invested in the Tokyo market makes it world's largest. Even the devastation wrought by last October's global stock only temporarily dampened the spirits of Tokyo traders. Although the Dow is now 12% lower than it was before the crash, the Nikkei has risen 6% above pre- crash level, to new highs.

The explosive growth worries some Western financial experts, who fear the boom could go bust. If that happened, investors with heavy losses in Tokyo could be forced to pull money out of other markets, triggering another crash. Japanese stocks are already trading at astronomical prices in comparison with the profits of the companies that issued the shares, at least by American standards. On the New York Stock Exchange, such price-earnings ratios run about 15 to 1, while in Tokyo the multiples are often four times as high. Nippon Telegraph & Telephone trades at 158 times its earnings. "Japanese authorities have allowed a speculative bubble to grow," warns George Soros, manager of the New York City-based Quantum Fund. "At no time in the past has a bubble of this magnitude been deflated in an orderly manner."

Such worries are groundless, argue analysts in Tokyo. The Japanese attribute the high price-earnings ratios in part to accounting rules that allow companies to understate earnings to keep their taxes lower. Another factor propping up prices is so-called cross-holding of stock. Because many Japanese companies hold large blocks of other companies' stock, which out of tradition are seldom traded, fewer shares are available for purchase so their prices rise.

Western critics charge that the Japanese manipulate the Tokyo exchange. After the crash, they contend, the Finance Ministry allowed mutual funds to postpone revealing their losses, then asked banks and insurance companies to buy shares in a mass gesture of patriotism. Many brokers purportedly encouraged individual investors to load up on stocks even if it meant dipping into debt.

Now money is flowing freely into the exchange once again. Many investors have shown faith in Japan's economy, which is expected to grow 4% this year. Government actions have also spurred more stock buying. Since postal-system savings accounts lost their tax-sheltered status in April, some of the $2.3 trillion invested in them has moved into the market. Also, the government has allowed life-insurance companies to boost from 3% to 5% the percentage of their assets that can be placed in special stock-investment funds, known as tokkin, which offer investors reduced exposure to capital-gains taxes.

Many analysts expect the Nikkei index to break the 30,000-yen barrier sometime this year. Says Hideo Nakazawa, general manager of Nomura's equity department: "We may hit some bumps, but the direction is up." Yet even Tokyo is unlikely to disprove the adage so often cited by bears in markets the world over: "No tree grows to the sky."

With reporting by Barry Hillenbrand/Tokyo and Frederick Ungeheuer/New York