Japan’s moment in the sun

06 May 2024

Please note: All data referenced in this article are sourced from Bloomberg unless otherwise stated, and are accurate at the time of publishing.

Whisper it carefully, but Japan’s economy and financial markets might have found their mojo again, at last. 

The country’s post-war boom crashed to a halt in the early 1990s, hit by the popping of an enormous asset bubble, allied to an ageing population and weaker productivity growth. An economic renaissance in China and new Asian ‘Tiger’ economies added to the competitive pressures. 

The lost decades

Try as the authorities might, whether through large stimulus measures or very easy monetary policies, the economic impact was minimal. This thirty-year period is frequently referred to as the ‘lost decades’.   

Despite its innovative streak, and strategic importance for the West, there is little doubt that Japan’s global influence has weakened too since the 1990s. The country’s share of global output has crashed from a peak of 17.8% in 1995 to 4.2% in 2022, according to data from Japan’s Cabinet Office.  

Land of the old 

Much of the reason for Japan’s poorer relative economic performance since the 1990s has been down to structural issues such as an aging population and restrictive working practices. As an example of the difficulties facing the economy, and businesses, over one in ten of the population are now at least 80 years old, and nearly a third of them are over 65. 

The surge in the number of retirees, the decline in the birthrate and the low levels of immigration have collectively shrunk the pool of labour available for companies calling out for more workers. Helping in this respect are women. The number of female employees participating in the workforce has risen from 47.6% in 2014 to 53.6% in 2023. 

Blast from the past?

Japanese companies might be paying the price for a country where almost a third of the population is aged over 65 and a labour supply that is constrained by lacklustre levels of immigration. However, the economy is showing more signs of life.  

The Bank of Japan’s (BoJ) latest quarterly Tankan survey shows that local firms are feeling more optimistic. Indeed, the largest service-sector companies are at the most bullish they have been on their prospects in three decades1. In addition, economic prospects should also be assisted by the impact that technology is having on tackling labour shortages. While more digitalisation could improve productivity rates.   

Encouraging inflation news

Japanese authorities have tried in vain to hit their inflation target. Instead, the country has had a long spell of falling prices, or deflation. At last, hope has sprung, as price rises start to emerge. The core consumer price index (CPI), which excludes volatile items such as energy and food from the index, hit an annual rate of 2.9%. 

Even more encouraging was that the main driver of the rise was higher wages. Barclays Investment Bank now anticipates that CPI will average 2.8% in 2024, and 2.2% next year. 

With the BoJ having exited its yield curve control measure and stopped an asset-purchasing programme in recent months, policy seems to be returning to something approaching normal. On the basis that inflation will hit the 2% target in the summer, the central bank is likely to make two quarter-point rate hikes by April, taking the rate to 0.5%. 

Outperforming equities

Only investors of a certain age will remember the days when Japanese equities regularly outperformed. What a retro act this year has been so far. The country’s benchmark Nikkei 225 index – having set an all-time high for the first time since 1989 in 2024 – is up 14.4% in the first four months. Meanwhile, the Euro Stoxx 50 has climbed by 8.8% and the S&P 500 by 5.6%, over the same period. 

Much of the heavy lifting of this year’s outperformance of domestic stocks against those in several other markets has been down to better earnings, and racier price-to-earnings (P/E) valuations. That said, in the shorter term, the valuations do not appear so attractive, given the risks from the heightened geopolitical tensions globally, a weaker yen and the potential impacts of the normalisation of interest rate levels. 

But, investors should not ignore the surge in Japanese earnings momentum of late, aided by a softer local currency. In addition, economic growth has been resilient and there are positive signs that the country’s corporate governance system will be strengthened soon. 

After many false dawns, Japanese equities could experience a longer winning streak. Cyclically-adjusted PE ratios suggest annualised returns of 9.2% over the next decade, outperforming the 7.1% suggested for global equities. That said, the shorter-term performance will probably be more disappointing in local-currency terms. 

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