ETF Investment News & Articles

Is Japan For Real This Time?

by Mark W. Headley

Source: Bloomberg

Japan has been the land of disappointment for investors for a very long time. Since the Nikkei 225 hit a peak of 38,915 in December 1989, thirteen years of falling markets brought the index to 7,603 in April 2003, a twenty-year low. The property market has fallen for nine straight years. Domestic consumption has been anemic at best. For six years the country has been mired in deflation that has undermined many companies and threatened the financial system with collapse. The government appeared helpless with little action beyond pork barrel spending on construction projects. Zero interest rates seemed to have little effect.

The reasons for Japan's decline have been endlessly discussed. The country experienced an enormous financial bubble in the 1980s. When the bubble popped, Japan was left with an aging, arthritic society that rejected foreign influences. Corporations made only half-hearted efforts at reform, when they tried at all. Lifetime employment remained in effect. Foreign workers were kept out, denying Japan's economy much needed skills and ruling out the development of its own "Silicon Valley" potentially filled with Indian and Chinese programmers. The domestic economy remained wrapped like a mummy in regulations and tax systems that discouraged change.

How much of this has changed? The country continues to age rapidly. There is still a great deal of corporate debt and a major mountain of public debt. Corporate Japan has made many efforts at reform, but usually at a slow pace. Workers are "retired" rather than fired. Still, a decade of gradual activity has, perhaps, achieved a tipping point. Most notable is corporate Japan's move into China. The logic of moving low cost manufacturing to China was ignored by Japan for a very long time for historical reasons. That resistance has ended and Japan's trade with China has gone through the roof. Remarkably, Japan is still running a trade surplus with China. At home, Indian software engineers are starting to invade Tokyo and temporary workers are becoming more acceptable. All of this should feed through to the profitability of Japanese companies, but it is unlikely to be enough to create a self-sustaining economic recovery.

The buzzword on the reports written in Tokyo is "reflation". The end of years of deflation with rising asset values, especially property, may have a very powerful effect on the domestic economy. Tokyo's property market has been showing signs of life for almost a year, and that now may be spreading to other regions. Combined with more coherent government policies and more profitable corporations, the case for Japan's comeback can be compelling.

If Japanese consumer sentiment improves and there is a hint of inflation, domestic spending could remain on an up trend. More profitable corporations, sensing a better local economy, may start spending their capital. This is the essential case for a sustained economic recovery. It does face major challenges.

Japan's export sector remains the economy's most efficient and profitable area. A strong yen threatens such exports. The strength or weakness of a currency always has a combination of good and bad impacts. While dampening export profits, the stronger yen encourages investment in Japan, including the repatriation of Japan's vast overseas investments. Employment is another big issue. While investors want a flexible labor market with low value manufacturing moved offshore, the impact on Japan is higher unemployment and consumer uncertainty.

One cannot take Japan's recovery with certitude. How dependent is the recovery on the recovery in the U.S.? What trick can the Japanese bureaucrats pull out of the bag to undermine the economy? Will corporate Japan backslide at the first signs of better days? The fact that Japan is back on global investors' radar screens is all you can be sure of.

The Nikkei 225 Stock Price Index is a price-weighted index of the largest Japanese companies.