Japanese GDP: The Good, the Bad and the Backward-Looking

Japan reported Q4 GDP Monday night, rounding out major developed nations—and it was a bit anticlimactic. The 0.6% annualized rise rebounded from Q3’s -1.0% slide, but it didn’t recoup the entire decline.^[i] It also missed expectations for a 2.4% rise as business investment fell and exports, while up, disappointed. Headlines couched the data as a puzzle for the Bank of Japan’s 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.

Japan has long struggled with weak domestic demand, tied largely to Corporate Japan’s sluggishness. There are a number of reasons for this, including structural factors (e.g., slow-moving labor and corporate governance reform progress) and monetary policy, which keeps the yield curve near-flat—and keeps a lot of legacy companies on artificial life support, preventing the economic force known as “creative destruction” from sweeping out the old and making the way for new, dynamic players. This all manifests in an economy that 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. Add in lingering COVID restrictions, and it was a rough year.

Q4’s GDP data were a microcosm of this. Household spending rose 2.0% annualized, accelerating nicely from Q3’s 0.1%. Government spending and investment combined accelerated to 1.4%.^[ii] Exports grew but slowed from 10.4% to 5.7% as the yen strengthened, reducing overseas revenues after conversion.^[iii] Imports, meanwhile, fell -1.6% after jumping 24.0% in Q3—both likely skewed bigtime by currency swings.^[iv] But business investment fell -2.1%, and inventories also detracted, which analysts tied to depleted stockpiles of automobiles and raw materials.^[v] Some good, some bad, and an overall “meh” result in a quarter that most observers anticipated would get a big boost from COVID restrictions lifting.

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. 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. This isn’t a judgment, mind you—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.^[vi] Relatively slow loan growth means there is less fresh capital to fuel investment.^[vii] None of this means the country is in perma-stagnation, but it points to multinationals leading while domestically focused businesses have a harder time.

Japanese stocks know this quite well. While global stocks enjoyed a rip-roaring bull market in the 2010s, Japanese stocks (in yen) endured bear markets in 2015 – 2016 and 2018. In 2021, they peaked in September as energy costs started rising. Then, last year, Japan performed in line with the world overall—not living up to its long reputation as a defensive country, likely because of its added headwinds. 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. But we also think that is rather beside the point. The simple question is: Do Japanese stocks know monetary policy is counterproductive? Yes. Have they learned how to get on with life anyway? Yes. Is it possible to zero in on the industries and companies that can thrive anyway? In our view, yes. When a country has a tough time, it often isn’t necessarily a call for avoiding it in a global portfolio. Being selective can be the right approach.