After the Covid-19 crash is Japan still a good bet for investors?

Naoki Kamiyamaexamines several points that will be key for the Japanese economy and the market to begin recovering.

The coronavirus pandemic will leave an indelible impact on economies and financial markets around the world, sparing no country, including Japan. That said, every crisis will eventually end and we discuss several points that will be key for the Japanese economy and the market to begin recovering from the effects of the pandemic.

Our scenario

For the Japanese economy and the markets to begin their recovery, there will first need to be a decrease in the rate of new Covid-19 infections. Projecting the timing of the economic recovery becomes possible once the rate of infections begins decreasing, which in turn will pave the way for the Japanese equity market to start normalising. 

The initial steps of an economic recovery will likely begin with a gradual normalisation of employment and individual consumption following the lifting of the state of emergency, which is tentatively planned for early May. In this scenario, the economic recovery begins in the July-September quarter and could run through the October-December, or even the 2021 January-March quarters.

However, the economy will probably lack the momentum to make a full recovery from the ground it lost in April-June. It will likely take some time for many businesses, even those that managed to survive the outbreak relatively intact, to rehire employees. Moreover, consumers may opt to save rather than spend in the early phases of the recovery. 

Within this scenario, the banking system remains relatively stable and corporate bankruptcies resulting from a shortage of working capital is limited. This would enable a relatively fast recovery in employment, which then leads to a recovery in consumption and an eventual decline in the rate of savings. 

However, the overall number of virus cases in Japan, which is still at a low level compared with those of other industrialised economies, could continue rising. But a sustained market recovery is expected to take place with the deceleration in the spread of the virus. We expect the market to recover moderately in tandem with the very gradual recovery by the economy. 

The market is expected to complete its recovery from the outbreak-induced plunge towards the end of the current financial year in March 2021. Within this main scenario, the Nikkei Stock Average will remain above the lows reached in March. The Nikkei could still slip beneath those lows again if the Japanese government decides to extend the state of emergency beyond early May and through the second or third quarter, but the possibility for such a scenario is limited, in our view.

Fiscal and monetary policies

Fiscal policy will also influence the market recovery. In our view, the Japanese government’s emergency fiscal spending, exceeding $1 trillion and roughly 20% of GDP, is sufficient to support the economy if it begins to recover in July-September per our main scenario. It is, however, very important that the government implements its emergency package effectively. The government does not have the option to simply mail checks to individuals like the US is doing, and reaching out to the needy in a timely manner will be crucial.

As for monetary policy, the Bank of Japan (BOJ) eased for the second consecutive month late in April, but we do not expect the central bank to make a drastic shift in its policy going forwards to combat deflationary pressures during the current crisis. This is because at the moment the BOJ’s main task is to keep the financial system stable and ensure, through quantitative easing, that banks do not pull back funds and cause liquidity within the system to dry up. The BOJ has managed to keep the financial system stable through its efforts, and we believe that it will ramp up its easing measures if the situation deteriorates further.

Quick recovery in individual consumption is key to recovery

In our view, Japan does not enjoy a particular advantage over its regional peers, including Taiwan and South Korea, in fields such as electronics, as any recovery in exports will have to wait for Europe and the US to begin recovering. When it comes to economic recovery, Japan might have a slight edge over Europe and the US. Normalisation in Japanese domestic demand is expected to be relatively quick if the country can continue to limit the number of virus infections and deaths.

The recovery in individual consumption could also be relatively swift if the government’s emergency policies are implemented in a timely manner. Another positive factor, at least in the short term, is the high number of cash-rich Japanese corporations, which has played a role in keeping the financial system stable during the current crisis.

Japan’s massive emergency spending plans have led some to worry about an impending fiscal crisis. The spending plans certainly exceed those the government compiled during the global financial crisis. But it is worth noting that the latest fiscal plans include steps that had already been prepared to cushion the blow on the economy from last year’s VAT hike. As long as the government keeps the higher VAT in place, the size of the emergency package appears reasonable, in our view. Japan is thus expected to retain its fiscal credibility in the long term despite the spike in short-term spending; as such, we see the country’s government bond yields remaining at a relatively low level.

Naoki Kamiyama is chief strategist at Nikko Asset Management.