ASIA MARKETS: Japan Undoes Rally; Market Mulls Election Impact

Japanese stocks gave up an early rally to turn negative Monday, in the first trading session after Japanese voters handed the opposition Democratic Party of Japan a landslide victory over the long-ruling Liberal Democratic Party.

The Nikkei 225 Stock Average ended the morning down 0.4% after opening sharply higher and rising to an 11-month intraday high in the first hour of trading. The broader Topix index of all issues on the Tokyo Stock Exchange's First Section was down 0.3%.

In other regional markets, South Korea's Kospi Composite was down 1%, and Australia's S&P/ASX 200 and New Zealand's NZX-50 % were both up 0.1%.

The Shanghai Composite tumbled 4.7% in morning trade over concerns of a fall in bank lending, which helped drag Hong Kong's Hang Seng Index down 2%.

The DPJ won 308 seats, a vast majority of the 480 seats in the lower house of parliament, compared with 115 seats previously. The LDP's representation fell to 119 seats from 300, and the LDP's coalition partner New Komeito's seats fell to 21 from 31.

The DPJ's victory over the LDP -- which has run the country since 1955 for all but a few months -- was widely expected. But analysts said the large margin of victory was interpreted as an initially positive sign, though not positive enough to sustain the gains in a market some say already shows signs of overheating.

"For the stock markets, worried about delays to important policies addressing population trends, the fact that the people have expeditiously given power to politicians is better over the long term than a narrow win," said Naoki Kamiyama, chief strategist at Deutsche Bank in Tokyo.

Kamiyama said that the Topix had shot up by around 300 points after the last election in September 2005, when former Prime Minister Junichiro Koizumi sought and received a mandate to reform Japan's economy. But, he said, this time could be different.

"Topix valuations are quite high at present, and market expectations regarding the economy are weak. Unless investors allocate greater resources to stocks, Japanese shares would not appear to have much upward leeway," he said in a research note early Monday.

"A switch in long-term political expectations to the positive would likely spur a rise in the long-term trading range. Still, we believe it will take at least a year to achieve a visible impact even with solid leadership," said Kamiyama.

Beneficiaries of 'overwhelming mandate'

The DPJ has an ambitious agenda of increasing social programs -- including paying cash allowances of more than $3,000 per child to families and abolishing highway tolls -- much of which is meant to shift Japan to more a domestic-demand-led economy.

"On the assumption that the DPJ will use its overwhelming mandate to rule at least in general accordance with its election platform, domestic and green stocks from health care, child care, and education to trucking, wind power, and batteries should benefit. Railroads, construction firms, general contractors, and tobacco could be on the losing side," said Cantor Fitzgerald economist Uwe Parpart.

Parpart said potential gainers include Watami Co. , a restaurant operator that also manages nursing-care facilities and makes box lunches for senior citizens. Other picks include household products maker Kao Corp. and transport firm Nippon Express Co. ;

Japan Wind Development Co. could benefit from the DPJ's emphasis on seeking green solutions and alternative energy sources. Honda Motor Co. (HMC) could also benefit from the DPJ's expected continuation of government incentives to buy hybrid cars. Battery maker GS Yuasa Corp. "may be worth another look," Parpart said.

"It will be a rough ride, but at least initially will be stocks-positive and bonds-bearish, as the DPJ attempts to revive domestic demand while ruling out new taxes to rein in growth of the huge public debt," Parpart said in emailed comments.

More active role

A stronger yen also helped knock some of the wind out of the stock market's earlier rally.

The dollar was buying 92.69 yen, down from 93.64 yen in late North American trading on Friday.

In the longer term, one factor to which currency-market investors should pay attention is the DPJ's vow to take a more active role in policy-making.

The DPJ party leader Yukio Hatoyama, who will likely replace the LDP's Taro Aso as Japan's next prime minister, pledged ahead of the election that his government would seek to temper the power of Japan's bureaucrats, who have traditionally held great sway over formulating policy.

While ministers are politically appointed, there are often viewed as wielding less power than the vice ministers, who rise up through the bureaucratic ranks.

However, such a shift would likely take time, blunting its immediate market impact.

"One cannot expect the Mandarins of the bureaucracy to simply roll over for the incoming government, so important drivers for the Japanese yen in the period ahead will likely be the generalized risk-appetite of global investors and the machinations around the fiscal half-year end for Japanese companies" at the end of September, said Marc Chandler, head of global currency strategy at Brown Brothers Harriman in New York, in emailed comments.