Why Japan’s GDP Contraction Looks Like a One-Off, Not a Warning

Early Monday, Japan reported Q3 gross domestic product (GDP, a government-produced measure of output)—and it landed with a bit of a thud, as headline output fell -1.8% annualised.^[i] Most coverage we read pinned it on falling exports, blaming the US’s new tariffs. In a roundabout way, we guess that is half right. But we saw something more interesting under the bonnet, with some timeless lessons for investors.

Exports’ -4.5% annualised decline does bear a lot of the blame, detracting -1.0 percentage point from headline GDP growth.^[ii] But this doesn’t look to us like tariffs suddenly wrecking demand for Japanese goods. Rather, exports surged 9.5% annualised in Q2 as US customers raced to take advantage of the 90-day US tariff implementation pause that began in early April.^[iii] With that context, Q3’s drop looks more like the standard pothole our research finds occurs when external events pull demand forward. It reminds us of Japan’s consumption tax hikes in the 2010s, when we saw many news reports of shoppers racing to buy big-ticket items before the rates went up. That caused consumer spending surges before the hikes took effect, with drops afterward.^[iv] Japan’s monthly trade data show export volumes rebounding in September from August, which suggests the tariff pothole may be relatively shallow, though we think the lack of seasonally adjusted monthly data complicates this a bit.^[v]

At any rate, exports weren’t the biggest detractor. That (dis)honour goes to residential real estate, which fell -32.5% annualised.^[vi] That is the third-worst decline in the last 30 years, with the other two surrounding the recession that accompanied 2008’s global financial crisis.^[vii] But in this case, we see a much more benign explanation: Japan’s building code changed in April, saddling home builders with tougher energy efficiency requirements, stricter safety codes and longer permitting approval times.^[viii] Well intended as this may be, for developers we find changes like this generally amount to reams of paperwork, higher costs and permitting delays. This caused housing starts to tumble, and it has like stalled home renovations, which also got caught in the crosshairs.^[ix] A large—and probably temporary—investment drop seems to us like a foregone conclusion as developers learned the new web of red tape.

And this brings us to the lessons. One: Well-intended regulatory changes affecting one corner of the economy can disrupt broad economic data. The headline results show private domestic demand dropping. But under the bonnet, consumer spending rose 0.6% annualised and business investment accelerated to 4.2%.^[x] The latter was the fastest growth rate since Q2 2024 and occurred against a backdrop of political uncertainty as Japan’s ruling Liberal Democratic Party lost its majority in the upper house and now-former Prime Minister Shigeru Ishiba navigated trade talks with US President Donald Trump’s administration and a very slow-motion resignation.^[xi] Faster growth implies uncertainty didn’t deter investment, which we think is a good sign of economic resilience.

Second lesson, and probably a counterintuitive one: This saga shows real estate’s economic footprint is limited. Generally speaking, if one hears a sector fell -32.5% annualised, one would logically expect a similarly huge detraction from headline GDP’s growth rate. But real estate’s plunge shaved off only -1.2 percentage points from GDP growth.^[xii] If a sector can fall by nearly one-third but scrapes only -1.2 percentage points off headline GDP growth, that sector is small. Which real estate is, at just 3.7% of total Japanese GDP in 2024.^[xiii] That is about as big as its footprint in the US (3.8% of GDP) and in the UK (3.9% of GDP).^[xiv]

Overall, we don’t see Japan’s economic contraction as a sign of creeping global economic risk. We don’t think it makes global recession more likely. Rather, we think it reminds investors the global economy will always have pockets of weakness and strength. In our experience, stock markets are good at looking at how those all balance out and zeroing in on what our research finds really matters: corporate earnings and how those square with expectations. Japan’s building code probably won’t have an outsized effect on earnings globally. We think it is just a reminder that sometimes GDP can fall for quirky reasons.