Notes from the Investment Floor: Is Japan the place to be?
Notes from the Investment Floor: Is Japan the place to be?
Mitesh Patel discusses the outlook for Japan as inflation, although rising, is far lower than other developed markets. What does this mean for investors?
Japan isn’t dancing to the same tune as the rest of the developed world, where inflation and interest rates are high. Indeed, I’m sure the US, UK and European Union would be delighted with the c.3% inflation that Japan is experiencing right now.
The good news for the corporate sector – and bad news for its employees – is that wage growth hasn’t yet materialised to match that higher inflation. The lack of wage growth is perplexing, because the Japanese labour market is as tight as it has ever been (meaning there is an abundance of vacancies but lack of people to fill them) and in other economies that would directly translate into higher wages. But there are cultural factors at play, with Japanese workers less inclined to quit a stable job in search of slightly higher pay elsewhere. Despite this, I do expect some sort of wage growth to appear in Japan over the coming quarters as unions negotiate with management against the backdrop of higher inflation.
The good news for the corporate sector – and bad news for its employees – is that wage growth hasn’t yet materialised to match that higher inflation. The lack of wage growth is perplexing, because the Japanese labour market is as tight as it has ever been (meaning there is an abundance of vacancies but lack of people to fill them) and in other economies that would directly translate into higher wages. But there are cultural factors at play, with Japanese workers less inclined to quit a stable job in search of slightly higher pay elsewhere. Despite this, I do expect some sort of wage growth to appear in Japan over the coming quarters as unions negotiate with management against the backdrop of higher inflation.
The wrong sort of inflation
Japan has been trying to fight deflation for more than a generation now, but this pick-up in prices isn’t exactly being celebrated because, instead of being generated by domestic economic growth and wage rises, it is being imported through higher energy and food prices as well as a weak yen.
That currency weakness has come about in no small part because the Bank of Japan aren’t in the mood to fight inflation through higher interest rates. Governor Kuroda is determined to keep interest rates low and, with his term in office due to end in six months’ time, there isn’t likely to be a change of policy at least until then.
How this yen weakness, in particular against the US dollar, impacts the corporate sector varies. The largest companies tend to also be quite export-heavy and also have significant overseas assets and earnings. For them, a weak yen is often a boon as they make more money in yen terms when they earn overseas in dollars (which makes a nice change, given how strong the yen was in the wake of the global financial crisis). However, for the more domestically-focused part of the Japanese economy, which will often have to import materials, a weak yen is much more challenging.
One growing issue for other developed markets, which Japan doesn’t need to worry about nearly so much, is the growing cost of refinancing debt. Not only are debt yields in Japan relatively low anyway, but the conservative way in which corporate Japan manages its balance sheets means that companies are on average far better capitalised.
That currency weakness has come about in no small part because the Bank of Japan aren’t in the mood to fight inflation through higher interest rates. Governor Kuroda is determined to keep interest rates low and, with his term in office due to end in six months’ time, there isn’t likely to be a change of policy at least until then.
How this yen weakness, in particular against the US dollar, impacts the corporate sector varies. The largest companies tend to also be quite export-heavy and also have significant overseas assets and earnings. For them, a weak yen is often a boon as they make more money in yen terms when they earn overseas in dollars (which makes a nice change, given how strong the yen was in the wake of the global financial crisis). However, for the more domestically-focused part of the Japanese economy, which will often have to import materials, a weak yen is much more challenging.
One growing issue for other developed markets, which Japan doesn’t need to worry about nearly so much, is the growing cost of refinancing debt. Not only are debt yields in Japan relatively low anyway, but the conservative way in which corporate Japan manages its balance sheets means that companies are on average far better capitalised.
The place to be?
These are all things of which we need to be aware as active investors when analysing investment opportunities in the Japanese market. On top of the strong balance sheets, share price valuations haven’t changed much over the past decade, corporate profit growth has been much healthier than the underlying lacklustre economic growth might lead a casual observer to expect. In my view all this combines to make Japan a relatively attractive place to be invested in the current environment.
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