The ugly attraction of fast shrinking Japan
Sure, seeing your economy shrink at a 15 percent annual clip is depressing, quite literally, but if you believe in even a tepid global economic recovery in the second half, then Japan is actually attractive.
There is no way to sugar coat the first quarter Japanese gross domestic product figures released on Wednesday: they are breathtakingly bad viewed from virtually any angle.
The economy shrank by a record four percent in the quarter, or an annualized fall of 15.2 percent, leaving the economy no bigger in real terms than it was in 2003. Net exports fell sharply, by themselves pushing GDP 1.4 percent lower and, perhaps even worse, capital spending shrank by more than ten percent and private consumption fell by 1.1 percent.
What’s more, stocks of inventory remain high when compared to sales, so there is plenty left to sell without placing new orders.
But just as global trade, and with it Japan’s economy, had an extended and sudden plunge in the wake of last year’s panic, there are signs already of an improvement.
Industrial production in March in Japan actually rose from the month before, up 1.6 percent, a rise echoed softly in the Reuters Tankan survey of confidence among manufacturers which showed less gloom than the month before.
A recovery will require a substantial recovery in exports, industrial output and household spending, according to Julian Jessop, chief international economist at Capital Economics in London.
“The strong rebound in the survey evidence confirms that this is realistic,” Jessop wrote in a note to clients. “The extent of the previous declines in exports and investment also leaves plenty of room for a decent bounce.”
That decent bounce could result in a nice return on Japanese shares, which have rallied in sympathy with global stocks.
Significantly, Tokyo shares actually rallied after the GDP news even despite a rise in the yen which crimped the competitiveness of exporters. And measured on a price-to-book value basis, Japanese shares, especially smaller cap issues, are among the world’s cheapest, implying decent potential for gains if the economy as a whole surprises.
Japanese shares as a whole are trading on a one year prospective price-earnings ratio of about 30.
LEVERAGED TO CHINA AND U.S.
Japan’s economy is very highly leveraged to global trade, making this perhaps the key call in any bet on a recovery there. Japan’s position is better than it might seem because those things which it does still successfully export are of high quality and technical specification and less vulnerable to cheaper substitutes from China or elsewhere.
A Barclays Capital composite leading indictor for Japanese exports, which tends to be three to five months ahead, has recently turned positive after a sustained and precipitous drop.
The index includes U.S. stock prices, commodity prices, new orders in the U.S. in both transport machinery and information technology, Chinese auto production and the relationship between U.S. inventories and sales.
Efforts by China to jump start auto sales seem to have worked particularly well, recording an 18.5 percent gain in April from the year before. Similarly, there is a reasonably good chance we are in the midst of a U.S. recovery of some sort, though the risks are it is short lived or chronically feeble.
As this happens look for a rebound in exports and production in Japan and even, at some point, in actual investment. This leaves us with the 20-year running sore that is Japanese domestic consumption.
The fear, and it is not a small one, is that employment and income suffer after a downturn of depression size and that already falling consumption retracts further. The gap between Japan’s output and its capacity is eight or nine percent now, making the risk of deflation, and with it the possibility of a negative spiral in spending, quite high.
Balancing that is the fact that Japan’s healthy savings rate gives its consumers an option less available to their U.S. peers when income falls, they can make up some of the shortfall by simply saving less.
Further, Japan is feeling the impact of a substantial fiscal stimulus, with at least some of the tax cuts finding their way into shopkeepers’ hands. Japan also has front loaded infrastructure spending.
As with all such spending, the impact of this is transient and, with the possibility of an election soon, there is no guarantee that further extra budgets will be forthcoming.
It won’t be glamorous, in part because the engine of growth will be elsewhere, but between now and the end of the year a rebound could be surprising and, depression-era style economic statistics notwithstanding, surprisingly profitable.
— At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund —