On October 1, Japan’s consumption tax will rise from 8% to 10%—the long-awaited sequel to April 2014’s increase from 5% to 8%. The tax hike arguably adds a headwind to Japan’s few domestic demand drivers—problematic since exports, a major source of Japanese growth, have faltered this year. Hence, many fear the tax increase will hamstring Japan’s economy and weigh on already slow global growth. But while it may skew Japanese economic data in the near term, we don’t think the tax increase materially alters the global economy’s outlook.
Many point to the aftermath of April 2014’s tax hike to argue this one will take a big bite out of Japanese growth. Household expenditures fell a striking -17.7% annualized in Q2 2014, driving a -7.3% annualized GDP contraction.[i] But we don’t think those numbers tell the whole story. In our view, while not a positive, the sales tax increase mostly moved consumption around rather than deleting it. This is par for the course: When a sales tax hike is forthcoming, consumers frequently move up big purchases or stockpile beforehand. By the time it happens, many have already pulled the trigger on that new washing machine, electronic device or other gizmo.
Something like this seems to have played out in Japan in 2014. Consumption rose 8.1% annualized in Q1 before the tax went into effect, helping GDP surge 3.9%.[ii] After consumption tanked in Q2, it rebounded in Q3, rising 2.9% annualized.[iii] Granted, consumption hasn’t matched Q1 2014’s level since. But that is primarily a function of measuring from an inflated base, in our view, not evidence of the tax’s enduring effects. So should Japanese economic data look extra sunny in Q3 and then gloomy in Q4, we urge you to take both with a grain of salt.
The tax increase’s implications for the global economy and investors are likely minimal. The global expansion weathered Japan’s last tax hike and associated GDP contraction. World GDP growth actually accelerated in 2014—2.8% versus 2013’s 2.6%.[iv] Markets have also had years to anticipate this second tax hike and price in likely outcomes—particularly given heightened coverage ahead of the October 1 start. We rather doubt it still packs big negative surprise power.
Moreover, the government is attempting to cushion the impact this time. Mitigating measures include cutting auto taxes, keeping the 8% sales tax for food and other “daily necessities” and offering rewards points—effectively subsidies offsetting the tax increase amount—to payment service providers on cashless purchases. If the purchases are at small or independent retailers, that is extra points! As a result, most of consumers’ front-running seems focused on large discretionary purchases (think: furniture and electronics) and household essentials, perhaps mitigating both the pull-forward and hangover.
Even if the effect is more pronounced, we don’t think it materially alters the outlook for Japanese stocks. Big multinational exporters already looked better-positioned than companies reliant on domestic demand. Despite Japanese exports’ nine straight monthly declines—most recently August’s -8.2% y/y drop in value terms and -6.0% in volume terms—these major multinationals’ global supply chains and offshore manufacturing hubs make the figures less reflective of their fortunes.[v] If anything, weak Japanese data and investors’ jitters over the global manufacturing slowdown may have soured sentiment toward Japanese multinationals. If this undershoots reality, positive surprise potential could build.
[i] Source: FactSet, as of 9/19/2019. Quarter-over-quarter annualized Japan GDP growth and household expenditure growth, Q2 2014.
[ii] Ibid. Quarter-over-quarter annualized Japan GDP growth and household expenditure growth, Q1 2014.
[iii] Ibid. Quarter-over-quarter annualized Japan household expenditure growth, Q3 2014
[iv] Source: International Monetary Fund, as of 9/19/2019. Annual percentage change in global GDP, 2013 – 2014.
[v] Source: Japan Ministry of Finance, as of 9/19/2019.
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