Lost years turned into lost decades for Japan as the economy went into seemingly permanent stagnation. Investors are at long last starting to believe that the tide has turned. A little healthy scepticism is called for.
Japan’s economy actually went from bad to worse in the third quarter of 2023 as an initial estimate of a 2.1% contraction in gross domestic product – the value of all goods and services produced within the country – was revised earlier this month to a 2.9% decline. Output in the three months to September was 0.7% lower than in the April-June quarter.
Consumer and business spending shrank. Since real wages and household spending continued to fall in October, the outlook for the fourth quarter is none too good. Consumer spending makes up more than half the Japanese economy.
Japan’s central bank is caught in a trap as it tries to phase out its accommodative monetary policy. Unlike Western central banks, it has held interest rates down even though inflation has remained persistently above the 2% target. Yet households continue to suffer as wages rise more slowly than prices and are likely to do so for the foreseeable future. Annual wage negotiations between unions and management this spring should be interesting.
The Japanese economy raced ahead in the 1960s and 1970s, producing cheaper goods from cutlery and watches to vehicles, until the Asian tigers such as Singapore, Taiwan and South Korea started biting into its export markets in the 1980s. Any subsequent recovery was snuffed out by the emergence of China as an exporter.
In the meantime, the notion of jobs for life in which Japanese companies and workers showed equal loyalty to each other crumbled.
The country’s main stock market index, the Nikkei 225, reached a peak in 1989 before enduring years of decline. This year has seen the most significant turnaround in the Nikkei’s fortunes for more than 30 years, with a gain of more than 30%, easily beating key indices in New York and London.
It should be said that part of that improvement has come because the yen has lost value against the US dollar, sterling and the euro, making purchases on the Tokyo Stock Exchange comparatively cheaper for overseas investors. This calculation also trims the value of share price gains when translated into other major currencies.
There is some speculation among foreign exchange traders that the Central Bank of Japan will at last start to raise interest rates, a belief that is already pushing the yen higher. The danger is that Japan has relied on exports for so long that it may have difficulty keeping the momentum going if those exports become more expensive in world markets.
Despite all that, Tokyo has been a great place to be for investors during 2023 and the momentum is likely to continue into 2024. The Tokyo Stock Exchange has introduced corporate governance reforms that should reduce any worries that overseas investors have about putting cash into a foreign country whose business ways and culture can be hard for Westerners to understand.
Experts believe the yen is likely to strengthen, or at least remain stable, in 2024 so now could be a good time to buy while pounds convert into more yen. It is true that yen gains could push Japanese share prices correspondingly lower but it opens up the possibility of double gains if the yen and the Nikkei both move higher.
Hopes for Japanese investment rely on two key factors. First, the country has been slower to recover from the pandemic, perhaps by as much as two years compared with Western nations. That means there could be pent-up domestic demand to be released alongside a recovery in tourism. Consumer products and services would probably be the main beneficiaries of such a scenario.
A snowballing effect would then promote wage growth, stimulating further demand, with Japanese companies able to raise prices and profitability without choking off sales growth.
Second, Japanese companies are estimated to have the equivalent of £700 billion cash on their balance sheets, which could easily fund increased dividends and buybacks while leaving enough to invest in the businesses.
One major concern is the impending serious decline in the size of the Japanese workforce. Younger Japanese have decided against getting married or having children, mainly because rising costs have compounded decades of worsening job prospects. That’s especially the case for women who are still treated with disdain if they are not married by the time they are 30 and are downgraded compared with their husbands if they do marry.
Japan’s birth rate declined for the seventh year in a row in 2022, and 2023 is likely to be number eight. The latest figure is 1.26 births per woman, a record low, compared with around 2.06 needed to keep the country’s population stable. The number of newborns in the entire country was only 77,747, another all-time low.
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Unlike developed Western nations, Japan does not have an influx of immigrants to take up the slack. Government initiatives to provide subsidies for pregnancies, births and childcare have had limited effect and promises by the current government to step up the package have been greeted with scepticism.
It takes time for a falling birth rate to feed through into a falling total population, but this is not a new problem in Japan. The previous record low for births per woman, 1.3, was set in 2005. Japan’s population has been dropping for 16 years. It currently stands at 125 million and is projected to fall to 87 million by 2070, with the decline starting in earnest in the 2030s.
As the country has one of the longest life expectancies in the world at 84 years, a shrinking workforce will need to raise productivity substantially to compensate.
In such a scenario, investors looking to gain a foothold or expand in Japan would probably do best to buy into investment funds specialising in the country. At least that gives a spread of investments. Those wishing to go it alone should concentrate on strong exporters.
Rodney Hobson is a freelance contributor and not a direct employee of interactive investor.
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