Outlook: Japan's stock market gloom is here to stay

Whatever the Japanese government does to revive its floundering economy, it is not going to be enough to revive the country's still more damaged stock market. Despite the euphoria with which last week's reflationary package was greeted, the stock market has since sunk back into gloom and despondency. Here's why.

Even the most backward looking members of the Japanese government now concede that the only way out of the bind Japan finds itself in is through structural reform. That means deregulation of service industries, liberalisation of capital and labour markets and a general opening-up of the country to foreign competition.

Unfortunately, the process of reform, as we know from our own experience in Britain, can never be an easy or short lived one. It is painful and disruptive and the positive results of it can take many years to show through. As we are already seeing, many companies in the protected service, construction and financial sectors will find it hard to survive. To make matters worse, long term demographic trends mean that Japan will have the most aged population in the world soon after the start of the new century.

There is nothing particularly surprising about all this. Many of these problems are present in almost equal measure in Europe too. The difference is that even at present depressed levels, Japanese stock prices are buoyed by valuations which are often twice the level of their Western counterparts. This can probably be justified in the case of Japan's big, internationally competitive corporations, but in the great bulk of companies that make up the Japanese stock market, it cannot.

Structural reform will highlight and expose the weaknesses of certain key sectors within the Japanese economy as never before. As the process of reform progressively integrates Japan into the world economy, her stock market and its valuations must become integrated too. The Japanese Government seems belatedly prepared to push all the right buttons. Unfortunately, this seems likely only to worsen the position of its deeply troubled stock market.