By Kay Van-Petersen, Global Macro Strategist, Saxo Bank
Has Abenomics been a success, or has it been a dismal failure for Japan? The answer to that question is likely to determine markets’ attitude towards the country as an investment opportunity.
“In a world of monetary policy experiments, Japan is on speed”
“Although debt levels are far from sustainable, almost all of the debt in Japan is in yen and held by the government or Japanese companies and citizens”
“Things are far from stale in the land of the rising sun”
Every day is historic in its own way, yet from financial markets’ perspective, the monetary policy cocktail that was produced in response to the 2008 financial crisis has brought us to the heart of uncharted territory in the largest financial experiment the world has ever seen. During this period, the world’s leading central banks, including the US Federal Reserve and its counterparts in the Eurozone, Switzerland, Sweden and the UK, undertook unconventional asset purchasing to bring interest rates to unprecedented lows.
While we have laughed at some of the unintended consequences of the monetary policy responses to the great financial crisis (such as being paid to take out a mortgage in Denmark), the truth is that capital markets, the cost of capital and the way our financial system functions have never been more synthetic.
Global debt has gone from around $175 trillion to over $250 trillion – it just does not feel like it because interest rates are still lower than before the crisis. While we have seen the Fed shift from quantitative easing to quantitative tightening, and the European Central Bank start the process with a projected move to QT by mid-2019, the Bank of Japan has in many ways been the most extreme of the world’s major central banks.
It has kept its policy rate at minus 0.10% since its surprise move to negative rates in early 2016, which was not at all well received by the markets. It has continued to buy Japanese government bonds and is now the biggest holder of them. It has also added equity ETF purchases over the last few years – an area that almost all central banks have avoided, with the notable exception of the Swiss National Bank, which holds billions of dollars in Apple shares, which are now down by over one-third from the highs of last year.
The key question now for many people watching Japan is: has Abenomics – of which the BoJ has been a pillar – been a success or a failure for Japan, and what can we expect for 2019? Let’s consider this both from bullish and bearish perspectives; as is generally the case, the truth lies somewhere in between.
So let’s look at two different scenarios.
Doom, gloom and dark thunderclouds: Japan, the BoJ and Abenomics are a joke
We are entering the seventh year since prime minister Shinzo Abe took office in 2012 and fostered his then-famous, now infamous, “three arrows” of Abenomics:
- Fiscal expansion
- Monetary easing
- Structural reform
With the objective of shaking Japan out of its zombie trance and multi-year deflationary environment, the idea was to stimulate sustainable growth that would benefit average citizens. Yet the mark to market on this has been far from great. Overall, it’s been just more of the same three arrows – monetary easing that has been tried and tweaked multiple times. The result is the BoJ’s balance sheet at $5.1 trillion (or JPY 552 trillion, at a 108 FX rate) as of December 2018, according to the BoJ’s website. This is equal to about 100% of the estimated $5.1 trillion Japanese economy in 2018 and more than 100% of the 2017 GDP figure of $4.8 trillion.
To put that in context, everyone goes crazy when they think of the Fed’s balance sheet of about $4.5 trillion, yet that is “only” about 21% of the US’s $21 trillion economy. For the Eurozone and the ECB, that ratio is more like 40%; for Japan we are talking 100%. So, in a world of monetary policy experiments, Japan is on speed.
Japan’s total government debt-to-GDP ratio is over 250%, a situation that is clearly not sustainable given the country’s demographics and growth. Third-quarter 2018 GDP figures were worse than expected at -2.5% against an expected -2.0%, which also included a revision of second-quarter 2018 growth to 2.8% after a -1.3% contraction in the first quarter. This is not an economic success.
Japanese corporate governance, while improved, is still abysmal. Remember the outright fraud and mismanagement at the likes of Olympus, Toshiba, Fujifilm and Takata – where, to my knowledge, no senior executives went to jail, even in the case of Takata where people, including Americans, died because of faulty airbags made in Japan.
At the same time, Renault-Nissan’s Carlos Ghosn (a foreigner) is now in jail for tweaking his pay – no doubt a poorly constructed and even more poorly executed strategy to keep Nissan from fully merging with Renault. This is not even apples and oranges, it’s more like gold and manure, and we’re likely to see the story told in a book and possibly a movie someday. The point is we are far from a level playing field in the Japanese corporate landscape. Shareholder and fiduciary rights are still at the back of the line.
The demographics are abysmal, with more adult diapers being sold than baby diapers. Last year the net decrease in Japan’s population accelerated to close to 370,000, bringing the population to 126 million. By 2050 the population is expected to have shrunk to just 108 million – that’s in just 31 years. The median age in Japan is around 47.3, compared with a world average of 30.4; for context the EU’s median age is about 43, while the US median is 38 and the Philippines has a median age of about 24. In fact, according to the CIA Factbook from 2017, there is only one country with a median age higher than Japan, and that’s the billionaire playground of Monaco at 53.1.
At the same time, Japan as an export nation faces a double whammy with its trade to China and the Eurozone. Both these regions are experiencing an economic slowdown that is showing no signs of ending yet, leading to less demand for Japanese goods. Additionally, China is climbing the value chain in production – especially in cars, machinery, automation, robotics and artificial intelligence – that minimises future market share and revenue for what was previously an uncrowded area for Japanese companies. On top of it all, Japan still needs to work out a trade deal with the US on its autos, and US subsidy/?/→duties/?/ on Japanese exports could have dire consequences for the Abe administration, especially after such robust global growth in 2018.
On the political side, there is no real opposition to check Abe’s Liberal Democratic Party. The consumption tax is coming up for review in October 2019, however, which had dire consequences last time it was passed in 2012.
Boom, butterflies and sunshine: Abenomics works, Japan offers compelling opportunities to invest
In this scenario, Abenomics is working, and things are far from stale in the land of the rising sun, with evidence of wage growth recently at 2.0% year-on-year against an expected 1.2%. The unemployment rate of 2.4% is a multi-decade low since the early ‘90s, with a trend of more full-time jobs coming online that will only increase the pressure on wages and inflation to rise.
While Japan has entered a recent soft patch in economic data terms, inflation (most recently with the core figure at 0.9%, like the Eurozone’s 1.0%) continues to be positive – a herculean feat for a country that was pretty much in deflation territory for decades. Furthermore, Abe has much stronger relations with US president Donald Trump, so reaching a trade deal between the US and Japan is easier than between the US and China, especially as intellectual property and technological theft is not an issue. It should be possible to start formal trade talks between Japan and the US in mid-January. Trump needs an easy win given the troubles he faces with the government shutdown, uncertainty around a US-Chinese deal and his continued loss of supporters.
Is Japan a country of xenophobes? Not so fast. The government recently passed a bill that would allow more immigrants into the country as it recognises that Japan’s demographic problems cannot be solved organically, and too many jobs are going unfilled. For the first time ever, a bill has been approved for 250,000 five-year work visas for unskilled workers. The change of perception in culture and Japanese society as a whole is accelerating, and many businesses would not be able to run without foreign workers.
Although debt levels are far from sustainable, almost all the debt in Japan is in yen and held by the government or Japanese companies and citizens, which should make any debt restructuring, defaults or haircuts easier to manage in the future. That is a much different situation than that of, say, an emerging market country whose debt is in USD while revenue and earnings are in domestic currency.
Japanese equities offer compelling opportunities, and not just on the fact that the Nikkei is down about 20% from the 24,448 highs of October 2018; many companies are sitting on a lot of cash. From a valuation perspective, one year forward price/earnings ratios are at a modest 13.0x without adjusting the price for cash on hand. The price/cashflow is about 8.0x, against 10.0x for the S&P 500, while the price/book also offers value at 1.4x, compared with 2.6x for the S&P 500.
A dividend yield on the index of 2.2% is not too shabby either (the S&P 500 is at 2.4%), especially when 10-year Japanese government bonds are yielding close to 0.0% and the front end of the curve is negative yielding.
Japan will host the 2020 Olympics, which should leave the fiscal spending side well supported. Abe’s leadership and his LDP have continued to solidify (his term of office lasts until 2021), which makes the case for long-term structural change that much more credible, as there is virtually no political risk to his administration, unlike the elections faced by political leaders in India this year and in the US in 2020.
Japan’s demographics are a positive, not a negative, factor. Because of its shrinking and much older population base, Japan has become a pioneer in healthcare and robotics. These are competitive edges that the country can export to the rest of the world. Over the coming decades, Europe and places like China will also start running into demographic challenges, including a shortage of workers, as well as needing care for their seniors (for instance, the median age in Germany is just a touch lower than Japan’s 47.3, at 47.1). So Japanese healthcare and, more importantly, robotics are likely to be multi-decade long investment themes.
In the robotics segment, the likes of FANUC Corp [6954], Omron Corp [6645] and Nabtesco Corp [6268] could be worth further research and due diligence by investors, especially as these three names have sold off by 50-60% over the last year from their January 2018 highs.
