Beyond Japan’s Surface-Level GDP Disappointment

This is going to sound weird, but stay with us: Japan’s Q3 GDP report was better than Q2’s. Yes, Q2 featured an acceleration to 4.5% annualized, which trounced the rest of the developed world, and that flipped to a -2.1% contraction in Q3.^[i] Yet under the hood, the details were much more encouraging—and better than most of the coverage acknowledged. While we still think structural factors favor being selective in the country, this suggests to us Japanese stocks have a nice wall of worry to climb.

While Q2’s acceleration looked good on the surface, the primary contributor was net trade. Exports’ 16.7% annualized growth was great news for multinationals, but it reflects external demand, not local economic health.^[ii] Imports are a better gauge of the latter, and they fell -14.5% in Q2.^[iii] Coupled with the -3.7% annualized drop in household spending and -4.0% fall in business investment, it seemed clear to us all was not well.^[iv] But a lot of the coverage focused on the headline number, preserving some false enthusiasm.

Most of the underlying categories still declined in Q3, so we aren’t calling this report an outright improvement. But they fell at much slower rates, suggesting things could be stabilizing. Household spending slipped just -0.2% annualized, while business investment’s decline eased to -2.5%. Positively, imports rebounded, rising 4.2% annualized, while exports’ slowdown to 2.1% growth seemingly reflects slower tourism growth after a big springtime pop, not a weakening world.

Yet most of the coverage portrayed Q3’s report as evidence storm clouds are gathering. Focusing on the big miss relative to consensus expectations for a -0.4% annualized decline, headlines said the contraction shows Japan needs more monetary and fiscal assistance. Many blamed demographic decline for weak household spending. In other words, all the usual bogeymen and scapegoats made an appearance, with all the usual policy prescriptions posed as solutions.

Reality, while not great, is hardly that bad. Energy costs are easing, which should help relieve pressure on households and businesses in this energy import-reliant nation. Judging from Japanese banks’ latest earnings reports, the steepening yield curve is a long-awaited boon. With more profitable lending comes more lending in general—fuel for future growth. And with a growing world eager to buy Japanese goods and services, there are plenty of tailwinds. Domestic demand may not be about to triumph once and for all over its long-running headwinds, but a modest recovery would qualify as a positive surprise at this point.