The Nikkei 225 has already fallen nearly 12% from a peak of 10,630.38 in the week of August 10, before the election of the new Democratic Party of Japan (DPJ) government. The reasons Japan's equity market is increasingly de-linking from global equity markets usually include, communication problems with new government and financial markets (i.e., the FT's "ministers of disruption"), the DPJ's lack of a growth vision (i.e., how do they plan to grow their way out of a growing mountain of government debt?), and of course the incessantly strong yen in the face of substantial volume declines in exports.
On a more basic note, however, the Japanese equity market has a major supply-demand problem. Domestic institutions continue to be persistent net sellers, while foreign investor buying is significantly more tepid than before the global financial crisis. Given already weak buying demand, what is becoming a rush of new stock issues has become a serious weight on stock prices.
Firstly, investors are most leery of the inevitable second round of large capital calls by the major banks. Mitsubishi UFJ FG has already announced a JPY1 trillion monster issue, and it is expected that Sumitomo Mitsui FG as well as Mizuho FG will be close on MTB UFJ's heels. Japanese companies have already procured some JPY3.48 trillion of equity capital so far this year, which is up 10-fold from last year, an amount which is more than the current market capitalization of Nissan, and could go as high as Honda's current market cap of JPY5 trillion. Major electronic firms like Hitachi and NEC also lined up to procure capital.
The problem with these issues is that they virtually ignore shareholders. Usually, companies shy away from issuing capital that represents more than 20% of dilution. In recent cases, however, these issues are representing massive dilution of 30%~40%.
In the case of the big three megabanks, the massive consolidation over the past 20 years, so-called restructuring and reduction of cross-holdings has not brought up these bank's capital ratios to where they really need to be. Standard & Poor's recently ranked 45 US/European/Japanese banks in terms of risk-adjusted capital ratios, and ranked the big 3 Japanese megabanks at the bottom because a large amount of their capital is "hybrid", i.e., something other than core equity capital. Mitsubishi UFJ FG has a core Tier 1 capital ratio of some 6%, which while the highest among the big Japanese megabanks, is still lower than global peers such as JP Morgan Chase, which has a core Tier 1 capital ratio over 8%. Sumitomo Mitsui FG's core capital ratio is around 5%, while Mizuho FG's core capital ratio is under 4%. This after these banks already procured JPY400 billion (MTB), JPY860 billion (Sumitomo Mitsui) and JPY530 billion (Mizuho) earlier this year. These banks were supposed to have weathered the global financial crisis in much better shape than their global peers.
While the DPJ government has recently re-initiated "zombie financing" by legislating that banks need to give financially struggling smaller companies a break on their loans, the big 3 megabanks were already backing away from SME (small and medium-sized enterprise) finance, with outstanding loan balances of JPY3.85 trillion and the end of September already down nearly 7% YoY. Several years ago, these banks tagged SME finance as a major growth area, but the only thing they got for their efforts to date from this finance are buckloads of NPLs (non-performing loans).
Like other struggling Japanese companies, major electronic firms are seeing their stock prices fall to 20-year lows as investors are pissed off about their highly dilutive issues, and the fact that they are strategically falling farther and farther behind their US/European and particularly Asian rivals in terms of new product and capacity expansion.
Finally, new international accounting standards coming into effect over the next couple of years are expected to result in significant reduction of cross-holdings, as valuation losses on these holdings will have to be reported under the new rules. Daiwa Research Institute estimates that the aggregate cross-holding ratio for Japanese companies has fallen in value from 13% in 2000 to 8.2% in 2008. In 1995, 91% of Japanese companies had cross-holdings with the banks, which fell to 55.8% in 2005, but was still nearly 51% in 2008. In 2008 alone, some JPY1.56 trillion of cross-holdings were sold, and these unwindings are again increasing after the global financial crisis and the anticipated introduction of new international accounting rules. Ostensibly, a complete unwinding of these cross-holdings (which is not likely) would affect 8% of the Japanese equity market's total market capitalization of some JPY279 trillion (or JPY22 trillion).
For those Japanese companies rushing to procure new equity capital, these issues are a strategic imperative and considered necessary for future survival. What Japanese corporate management ignores, however, is the unspoken agreement between they as shareholder capital users and shareholder capital providers--i.e., investors invest their (or their sponsor's) savings in a company with the expectation of earning a competitive return on their capital.
If the company (issuer) cannot provide a decent return on shareholder capital, there is no reason for an investor to purchase that company's shares. Despite the fact that the Nikkei 225 is still some 76% below 1989 highs, and the market capitalizations of an increasing amount of companies continues to shrink and demoting them from "large cap" to "small cap" companies, the majority of Japanese management still do not get the joke, i.e., you have to offer a competitive return and/or capital appreciation potential if you want your investors to continue to support your stock. As their market cap continues to shrink, they cannot understand why an increasing number of domestic and foreign institutions are finding they are now too small to be included in big funds requiring a minimum of market capitalization and market liquidity.