Japan represents an anomaly among the world’s economies, and while its economic characteristics haven’t changed much in recent years, the stock market performance has certainly not followed suit.
Japan’s economy is unique in that it has barely grown for decades, suffers from an ageing population and poor demographics, and has had near-zero inflation for decades, yet somehow it remains one of the wealthiest countries as measured by average income for its citizens.
From the outside general consensus seems to be that Japan must generate inflation and get citizens to spend more in order to stimulate growth. The last few years aside, Japan has had a relatively strong currency for a long time, and as a result, exports have suffered from neighbouring countries able to offer goods and services far more cheaply. Domestic corporate investment in the economy remains low, and people feel comfortable keeping savings in liquid bank accounts as frequent periods of deflation actually make cash balances pay off.
Japan’s GDP growth rate has arguably been significant for only two years in the last 15, and there were few major sources of growth behind the economy in recent years. However, in late 2012, Prime Minister Shinzo Abe launched an aggressive campaign to invigorate the economy. The Japanese central bank embarked on a historically massive easing of monetary policy, ranging from gigantic quantities of bond buying to the more recent move to negative interest rates in January last year.
The policies initially seemed to gain significant traction, inflation expectations climbed, the yen weakened, and equity markets surged. However, since 2015 the impact has dwindled, the economy has slumped, and investors have turned sour on further economic or inflationary gains. In efforts to regenerate momentum, the PM has flirted with more fiscal expansion, and the central bank has hinted at reducing interest rates further, but without follow-through.
From a credit perspective, even though the country has solid credit ratings, Japan’s debt ratios are intimidatingly large. Currently above 240%, Japan’s debt-to-GDP ratio is projected to climb towards 300% by 2030 according to the IMF, unless policies change dramatically. While these sound like unsustainable levels of debt (Greece is at 175% and Italy around 120%), markets continue to remain calm about the issue as Japanese savings are high enough to absorb the debt for the foreseeable future. In the longer term, however, unless the country grows, inflates its debt, or undergoes a significant fiscal adjustment, debt could be a real problem.
Despite its rank as the third-largest economy in the world, Japan has relatively few investment options for the global investor. Most activity is focused on the equity, currency, and government bond markets. Each of these markets tends to go through significant periods of range-bound prices and low volatility, and then long periods of identifiable trends. Generally speaking, since the early 2000s, yen weakness has been correlated with equity strength. The stock market peaked in mid-2015 and had slumped since, while the currency has strengthened relative to the dollar.
However, despite the doom and gloom, there are reasons for investor optimism surrounding Japan. The labour market is at its best level since the ’90s with unemployment under 3%. Domestic corporations have significantly cut costs in recent years, are cash-rich, and becoming more shareholder focused, meaning higher dividend payments. Inflation is slowly on the rise, and compared to most developed countries equities are relatively cheap. Surprisingly since the start of 2015, the TSE Topix has grown by 48.22%, while the S&P 500 by 43.80% and the FTSE 100 only 19.10%, so clearly not all is bad. Japan’s market tends to follow identifiable trends suggests we may see this period of steady growth persist, although signs may be needed that the government is speeding up fiscal spending, or debating policies that boost confidence in the policymakers’ ability to enact reforms.
There seems to be a lingering negative sentiment surrounding the Japanese market, much of which might be based on historical bias. History has taught us that things in Japan do not change overnight, but rather take the slow and steady road. For short-term investors, undoubtedly there are stronger and quicker gains to be made elsewhere. However, for any investors looking at the longer-term picture, it may well be worth taking positions in Japanese equity while the valuations remain cheap and holding on to them. You just might be pleasantly surprised.
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