The spectre of “Japanification” has been a concern in western economies for a long time. Copying the “Japanese model” of debt, weak economic growth, persistently low interest rates, and deflation was never the most appealing proposition, but that’s where we ended up. And yet - surprise-surprise - the Japanese themselves are actually not doing so bad, relative to Western advanced economies. We received quite a few comments and questions from the readers of the Special Report (On the Brink of a New Era – Are You Prepared?) we published recently and sent to our clients and partners. We’ve decided to try to respond to some of the questions we received back right here, in our blog posts.
A few of our readers asked why we did not discuss Japan in more depth. One in particular asked: “What is your view on the Japanese stock markets?”
We did focus more on the US and Europe, and to some degree, on China, in our report. This also had to do with the fact that, when it comes to the dimension of social unrest and change, America and Europe are far more affected by the current developments than Japan. However, when it comes to debt, Japan certainly deserves its fair share of attention. And the Japanese stock markets too deserve some attention, also in consideration of the recent change of leadership in the nation (from Shinzo Abe to Yoshihide Suga).
So, here we share a few points worth thinking about and a bit of an assessment of Japanese equities.
Concerns over “Japanification”
In general, Japan has been seen as a negative role model economically during the past two decades or so, while fears and dire warnings over the possible “Japanification” of the developed world have been the subject of countless economic analyses and opinion pieces.
The term “Japanification” is shorthand for the many challenges that we face economically today, which have been underway for much longer in Japan. In particular, the term refers to, among other things, a growing mountain of debt stemming from a combination of weak economic growth rates, persistently low interest rates, and the absence of inflation despite the extreme levels of monetary and fiscal policy support.
Countries with the largest national debt burdens in 2020 (% relative to GDP)
Source: statista.com, IMF
To put the Japanese debt levels into perspective, it is worth looking at the chart above, which provides an overview of the countries with the largest national debt burdens relative to GDP. With a 238% government debt-to-GDP ratio, Japan is even worse off than the permanent default candidate, Greece. However, the economic story of Japan is very different, and not only in terms of its size and global relevance.
Japan doing better than “they” say
Japan has not been doing so badly – at least not as badly as some of the more extreme headlines may have indicated. And certainly, as may be implied by the chart above, the Japanese economy is not generally in the same category as Sudan, Eritrea, Cape Verde, or even Italy, for that matter.
Although Japan too will ultimately pay the painful price of excessive debt and deficits, as discussed in our Special Report, the stock market of Japan can be considered attractive in some ways. GDP growth
The biggest issue faced by Japan, in the long-term, is demographics. The correlation of positive birth rates and GDP growth is well documented. Since the start of the last decade, Japan’s working age population had contracted by around 0.5% a year. Yet despite this, GDP increased by an average of 1.3% per annum. GDP per capita increased by an average of 1.5% annually. While this is not a stellar performance, it does not amount to the “lost decade” of growth that some have used to describe Japan’s economic experience.
Strong labor market
Japan’s labor market has been comparatively strong. Unemployment is at record lows and much lower than in most other developed nations, even more so now, after the COVID crisis. Meanwhile, the participation rate is rising. In other words, overall employment has never been higher.
Moreover, Japan stands out for having one of the lowest COVID-19 infection rates among major economies, which we believe will help manufacturers restart idle facilities and get production back to pre-pandemic levels. Unlike many developed markets, Japan’s unemployment rate did not spike when infections peaked, so getting workers back into their previous roles should be fairly straight-forward.
Healthy corporate balance sheets
Another very positive factor after Japan’s quasi-depression of the last 20 years is its corporate balance sheets, which have been cleaned up considerably since the “wild days” of financial engineering adventurism in the late 1980s. Corporate Japan has strong balance sheets with healthy margins and profitability. This stands in particular contrast to the situation in the US, where the quality of the balance sheets has deteriorated considerably over the last few years. Fixed Income investors turning toward stocks Traditionally, the Japanese have been savers and fixed-income investors. This is partly based on the stable currency they have enjoyed since WWII. This is comparable to Germany or Switzerland. By contrast, Anglo-Saxon nations with continually weakening currencies (US, UK, Australia) have been more equity-oriented investors. However, in Japan, the tide has started to change. In recent years, the Japanese have started to invest more of their wealth in equities due to a lack of yield return in bonds. Thus, there may be a positive-flow-of-funds factor for Japanese stocks. Culture and social cohesion matters
Possibly one of the most important economic differentiators of Japan is found in its relatively homogenous society and cultural cohesion. This aspect, combined with a relatively stable political system, is not easily found in the western developed world, at least amongst the major players.
Japan’s stocks relatively attractive
All of the above-mentioned factors point toward a relatively strong Japanese stock market. In addition, Japanese stocks remain extraordinarily inexpensive by many investment measures, including earnings, dividend yield, and price-to-book. Finally, we believe that, based on the fact that Japanese companies have relatively healthy balance sheets, in the current period, Japanese stocks will benefit when investors turn more from growth to value. While Japan also has some growth stocks, the large cap stocks in the Nikkei index are predominantly value/cyclicals.
In aggregate, we believe Japan offers some opportunities for equity investors facilitating a direct play on global economic progress. The country’s political stability, increasingly rare in the world, is an important plus. There are few equity markets that can claim to have a global pandemic well in hand, boast low valuations, compelling dividend yields, and a leveraged link to manufacturing production. Nikkei 225, since 2016
Source: yahoo!finance So, in conclusion, for as long as global equity markets go up, or after the next setback, taking a close look at Yen-denominated, Japanese equities could prove very interesting.
And we will certainly not exclude Japan from our own considerations, even if we did not mention Japan in-depth in our Special Report.