By MARCEL PORCHERON 09/08/2006
The times are certainly a’ changing in Japan. The stockmarket has doubled in value from its low point early in 2003 and on 17 July Japan’s central bank raised its key interest rate from 0% to 0.25%, the first increase in nearly six years. These are both strong signals that the Japanese economy has finally pulled out of the recession, having languished since the early 1990s. The end of deflation is especially important milestone, as during the era of falling prices consumers and businesses were reluctant to spend or invest because any purchase was likely to be cheaper in future.
I recently took a trip to Tokyo re-evaluate the economic situation in Japan and the potential for renewed growth in markets.
| "What makes for good service can also lead to high costs for companies and stagnant wage increases for employees." |
My initial impression was that Japanese society has retained some strong elements of traditional culture whilst also incorporating Western ideals. Strong ethics, hinged on respect for elders and superiors, dominate both social and business life. In contrast Shibuya girls, young trendsetters, characterise the youthful side of the economy. They typically work in clerical roles, which are not highly paid but have high disposable incomes as they often still live with their parents. There is also a high level of staffing, which we in the West would regard as excessive: for example, there was a lift attendant waiting by each of the ten lift doors in the lobby of my hotel. What makes for good service can also lead to high costs for companies and stagnant wage increases for employees.
One of the most compelling arguments for the Japanese market is that the Japanese have very little invested in domestic equities relative to western peers. Savers could be encouraged by negative real interest rates and rising equity markets to invest more. The potential flows are enormous; some commentators suggest a move towards western levels could equal a shift in excess of ¥100 trillion into equities. The chart below compares the estimated assets of individuals in Japan, the USA and Europe.
Demographics may also impact. Japan’s current population of 128 million is likely to start falling soon, as a result of a low birth rate and negligible immigration. This will inevitably have a negative impact on overall GDP but it does not necessarily mean bad news for the economy or stockmarket. The current population has bulges in the 30-34 year old group and as they grow older we can expect them to become bigger spenders. The reduction in the work force should lead to greater efficiency as surplus labour disappears.
- When speaking to fund managers the overriding investment case for Japan was the potential for growth in corporate earnings, on which the managers were generally positive for the following reasons:
- As Japan moves out of being a deflationary economy, to an inflationary one, spending should pick up and asset prices should increase. Companies focused domestically, typically smaller companies, are set to benefit.
- The age of Japan’s capital stock is on average 12 years, well above western peers, so higher capital spending by cash rich corporates is expected.
- All of the fund managers that we met took the view that most companies’ estimates for ongoing profit growth of 0-5% are far too conservative, with 10-15% being more realistic. A key reason is company management’s desire not to disappoint the market and for fear of weakening their negotiating position with suppliers.
- Pricing power is returning to businesses as output prices rise.
However, there are reasons to temper such optimism:
- High public debt and a shrinking population. The Government need to raise revenues and consumption tax (i.e. VAT) is expected to rise in 2007/08.
- Risk of a policy error from the Bank of Japan. The Bank has a history of poor decision making, raising interest rates too quickly could stifle economic growth.
- Prime Minister Koizumi retires in September. Uncertainty over his succession could impact markets, although it is believed that his replacement will continue the reform mandate.
| "On balance, we are a little cautious regarding Japan." |
On balance, we are a little cautious regarding Japan. While there are certainly compelling reasons to be optimistic longer term, the shorter term outlook is very mixed. We are especially concerned that market ratings are relatively high and that the Bank of Japan’s record on global policy changes is poor.