Japan reported Q4 gross domestic product (GDP, a government-produced measure of economic output) early Tuesday, rounding out major developed nations’ reports—and it was a bit anticlimactic, in our view. The 0.6% annualised rise rebounded from Q3’s -1.0% slide, but it didn’t recoup the entire decline.[i] It also missed analyst expectations for a 2.4% rise as business investment fell and exports, whilst up, disappointed.[ii] Headlines in publications we follow couched the data as a puzzle for the Bank of Japan’s (BoJ) incoming policymakers, including newly nominated (potential) head Kazuo Ueda: How can they wind down so-called monetary easing without derailing a fragile recovery? We think this distracts from the larger point: Q4 didn’t signal any new developments in Japan. Rather, it merely confirmed the country’s long-running challenges, which stocks are well aware of, in our view.
According to our review of its economy, Japan has long struggled with weak domestic demand, tied largely to Corporate Japan’s sluggishness. We see a number of reasons for this, including structural factors (e.g., slow-moving labour reform progress) and monetary policy, which flattens the yield curve (a graphical representation of a single issuer’s interest rates across the spectrum of maturities)—and keeps a lot of legacy companies on artificial life support, preventing the economic force known as creative destruction from sweeping out older, less-viable businesses and making the way for new, dynamic players.[iii] This all manifests in an economy that our historical analysis shows gets by on household spending, government activity and exports, with business investment mostly floundering. Last year, the country faced added headwinds from the weak yen, which raises import costs, and higher energy prices—also exacerbated by the weak yen, given Japan imports much of its fuel.[iv] Add in lingering COVID restrictions, and it was a rough year.
We think Q4’s GDP data were a microcosm of this. Household spending rose 2.0% annualised, accelerating nicely from Q3’s 0.1%.[v] Government spending and investment combined accelerated to 1.4%.[vi] Exports grew but slowed from 10.4% to 5.7% as the yen strengthened, reducing overseas revenues after conversion.[vii] Imports, meanwhile, fell -1.6% after jumping 24.0% in Q3—both likely skewed bigtime by currency swings.[viii] But business investment fell -2.1%, and inventories also detracted, which analysts tied to depleted stockpiles of automobiles and raw materials.[ix] Some good and some bad and overall mediocre results in a quarter that most observers we follow anticipated would get a big boost from COVID restrictions lifting.
Our research shows that isn’t really a change from past quarters or even past years. Business investment was choppy before the pandemic and has been choppy since.[x] Exports have long contributed mightily to growth without boosting investment, as businesses have largely chosen to pocket the profits from currency translation rather than boost output.[xi] This isn’t a judgment, mind you—we think they are largely following political and socioeconomic incentives. Banks don’t have an appetite for much risk, given they have long complained that BoJ policy makes lending uneconomical.[xii] Relatively slow loan growth means there is less fresh capital to fuel investment.[xiii] None of this means the country is in perma-stagnation, but we think it points to multinationals leading whilst domestically focussed businesses have a harder time.
We think Japanese stocks know this quite well. Japanese stocks (in yen) fared worse than world stocks during market downturns in 2015 – 2016 and 2018, undercutting Japan’s longstanding reputation as a defensive country—one that would lead when global markets are weak.[xiv] In 2021, Japan peaked in September as energy costs started rising.[xv] Then, last year, it performed in line with the world overall—again failing to demonstrate defensive traits, likely because of its added headwinds.[xvi] In our view, there is little negative surprise power left at this point.
Japanese monetary policymakers old and new also know all of Japan’s challenges—but whether they will apply the most beneficial prescription remains to be seen. It isn’t possible to project from the nominees’ past writings, interviews or policy decisions, contrary to the many think pieces we have seen this week in publications we follow. But we also think that is rather beside the point. In our view, the simple question is: Do Japanese stocks know monetary policy is counterproductive? We think the answer is yes. Have they learned how to get on with life anyway? In our view, yes. Is it possible to zero in on the industries and companies that can thrive anyway? Again, we think the answer is yes. In our experience, when a country has a tough time, it often isn’t necessarily a call for avoiding it in a global portfolio. We think being selective can be the right approach.
[i] Source: FactSet, as of 14/2/2023. Annualised growth rates represent the rate at which GDP would grow over a full year if the quarter-on-quarter percent change repeated all four quarters.
[iii] Ibid. Statement based on 10-year Japanese Government Bond minus 3-month Japanese Government Bond yields.
[iv] Ibid. Statement based on yen value compared to the dollar, pound and euro and Brent crude oil spot prices, 31/12/2021 – 31/12/2022.
[v] Source: FactSet, as of 14/2/2023.
[x] “Japan’s Weak Private Demand Is the Dominant Challenge for Abenomics,” Martin Wolf, Financial Times, 11/1/2016. Accessed via the Australian Financial Review.
[xi] “Japanese Companies Are Making Less but Profiting More Thanks to Weak Yen,” River Davis, The Wall Street Journal, 9/11/2022. Accessed via the Internet Archive.
[xii] “Why is Japan’s Monetary Policy So Unpopular With Banks?” Staff, Reuters, 18/9/2018. Accessed via the Internet Archive.
[xiii] Source: Bank of Japan, as of 14/2/2023. Total Japanese bank lending rose 3.1% y/y in January 2023.
[xiv] Source: FactSet, as of 15/2/2023. Statement based on MSCI Japan return with gross dividends, 1/6/2015 – 12/2/2016 and 23/1/2018 – 26/12/2018. Presented in yen. Currency fluctuations between the yen and pound may result in higher or lower investment returns.
[xv] Ibid. Statement based on MSCI Japan Index return with gross dividends on 14/9/2021 and Brent crude oil spot prices. Presented in yen. Currency fluctuations between the yen and pound may result in higher or lower investment returns.
[xvi] Ibid. Statement based on MSCI World Index return with net dividends and MSCI Japan Index with gross dividends, 31/12/2021 – 31/12/2022. Presented in yen. Currency fluctuations between the pound and yen may result in higher or lower investment returns.
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