Japanese Market Continues to Underperform

A last minute rally couldn't save Japan from being the worst performing of all the major markets in November as worries over the government's financial position increased, and asset allocators and fund managers across the globe began to wonder whether they should be in Japan at all.

The Nikkei dipped 6.3% to 9,282, compared with monthly rises of 2.9% in the FTSE 100, 5.7% in the S&P 500 and 0.9% in the FTSE Eurofirst index. Much of the fall was based on worries over the strength of the yen, which threatens to derail the country's fragile recovery. Japan's government has said it will extend the country's stimulus package to break the yen's strength, but the coffers are already at breaking point – the government debt to GDP ratio is expected to hit 200% in 2010. The likelihood of default is increasingly being factored into bond markets.

Deflation is expected to persist into 2011 and the central bank is now under significant pressure to do more to combat the problem. This may take the form of quantitative easing, though the government has been publically sceptical about its value in the past. That said, it has already used up many of its chips to fight persistent economic weakness and international investors are now wondering what it has left.

Earlier in the month, the country's economic figures seemed encouraging. Third-quarter GDP growth figures were strong at an annualised 4.8%, with expansion split evenly between private consumption growth, increased inventories and an improvement in net exports. Exports fell 23.2% in October compared with a year ago. This may not sound that impressive but it represented an improvement on September's 30.6% fall, while exports to other Asian countries were particularly strong.

But a raft of poor data followed at the end of the month. In particular, industrial output numbers released at the end of the month were weak. They grew by an anaemic 0.5% in October over November, well below expectations. Analysts are still worried there is little organic growth in the economy and the removal of the stimulus packages next year will see another lurch downwards.

Japanese funds fared little better and look like being crowned the worst-performing equity sector of 2009. They have returned just 5.1% over the past 12 months, ahead of only the UK gilts and money market sectors. North America is the next closest equity sector and that has returned 21.4%