Updated: May 19, 2022
I scarcely realised it at the time, but when I arrived in Tokyo as a graduate trainee in 1989, I was to see economic history in the making. Decades of strong economic growth had produced an enormous asset price bubble, which popped spectacularly before my eyes. Outlandish stories abounded of the scale of the bubble – at one point the land on which Tokyo’s imperial palace was built was reputed to be worth more than all of California’s. Another tale – one that may actually have been true - held that New Zealand solved all its budget deficit problems one year by selling off a tennis court adjoining its Tokyo embassy.
"To the young woman employed to stand in the lift to welcome customers, the years were not lost"
Between March 1971 and December 1989, Japan’s TOPIX index returned 6,011% in sterling terms, equivalent to 24.5% per annum. And that’s excluding dividends! By the end of the 80s, Japan accounted for 40% of the MSCI World index; not bad considering its share of the global population was just 2%. Its car and silicon chip makers were on top of the world. The Japanese must have felt invincible, the perfect position from which to crash hard. Which is exactly what happened.
The years that followed the 1990 crash first became known as Japan’s lost decade, then Japan’s lost decades, as growth slumped and inflation turned negative. Whether the years really were ‘lost’ depends on your perspective. Sure, if you were an investor, they were indeed miserable years. However, jobs that in the US or other parts of the western world would have been cut at the first hint of trouble, in Japan were kept. To the young woman employed to stand in the lift at the Mitsukoshi department store just to welcome customers, the years were not lost. Indeed, Japan’s unemployment rate during its two ‘lost’ decades averaged 3.8%, compared with those in the US, UK, France, Germany, and Australia, respectively, of 5.7%, 6.8%, 10.0%, 9.8% and 7.1%.
Japan’s response to the crash was evidently to favour employees over shareholders; something for which, given the circumstances, it should be admired. In many respects what Japan has been through over the last 25 or so years was inevitable and necessary. The balance sheets of banks, companies, and individuals were horribly geared towards property, and thus needed to shed leverage. This has happened, albeit slowly, and much private sector debt has been replaced with public sector debt – the latter now accounts for 226% of GDP – though a cumulative current account surplus equivalent to 57% of GDP has also helped.
So, here we are in 2014, with strong private sector and commercial bank balance sheets and signs of inner confidence coming back. Things could be getting interesting again. Prime Minister Abe and central bank governor Kuroda are desperately trying to get the private sector to put its strong balance sheets to work, but it is a big challenge. Kuroda has succeeded in raising Japan’s inflation rate, from -1% in March last year to 3% as of October. He appears absolutely determined to keep it well above zero, evidenced by the surprise announcement at the end of October to ramp up the Bank of Japan’s monthly asset purchases from Y60-70 trillion to Y80 trillion.
In addition to this massive monetary stimulus, Japan is also increasing fiscal stimulus as well as introducing structural reforms. The problem is that even with all this encouragement, Japan’s economy is hardly stirring. Third quarter GDP fell 1.6% on a seasonally adjusted, annualised basis, compared with economists’ expectations for a rise of 2.2%. True, declining inventories had some impact, but this was not the sole reason. The decline was in fact less than the average for the previous five quarters, so should not have been a surprise. Nor was private consumption to blame, although at +1.6% annualised, this was slightly weaker than expected. No, the culprit was business spending which fell by 1% on an annualised basis compared with an expected +4%.
Abe’s response to these numbers was to announce that the next scheduled increase in the consumption tax was to be postponed. This appears to be more a political than economic move, given that personal consumption had held up quite well in the third quarter. Kuroda’s response on the other hand has been more measured and rational. In a speech to business leaders on 25 November, he urged companies to start spending more wisely, saying that hoarding cash would be a very bad idea in what he suggested would continue to be a negative interest rate environment.
Although CEOs have yet to get their wallets out, there are signs of changing attitudes. Not long ago, few in Japan knew what the term “ROE” meant; now it is bandied about by company presidents and splashed all over the newspapers. The creation of the Nikkei 400 index – inclusion in which is based on strange, foreign criteria such as profitability - has had the desired effect of pushing companies to focus more on shareholder returns and better corporate governance. It has been dubbed the Shame Index as exclusion from it is deeply embarrassing, something the Japanese fear almost as much as we do.
Top down, it is hard to see Japan going off to the races. Its demographics remain a serious headwind and, as a developed nation, the scope for productivity increases is limited. Furthermore, Japanese equities are not obviously cheap, with the Nikkei 225 now trading on a trailing price-to-earnings ratio of 21 times. The opportunities going forward for investors I suspect will be more for the stock picker than for the ETF buyer, as clever CEOs find ways to tap into the “growing inner confidence” and grab market share.
That said, if there is one industry to watch, it is construction. This was the sector hit hardest in the 90s, with many companies going bankrupt. However, given that balance sheets at banks, corporations and households are once again strong, the country is ripe for another property boom. The Japanese are a strongly conformist people, and if they decide that it is time to start building again, the result could be profound.
Published in CityAM
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.