Japan’s domestic investment finally grows as the yen weakens
The below graph reflects “The Great Exodus” of capital leaving Japan since 1990. When the Japanese bubble economy burst in 1990, Japan ceased to attract investment at the rate it had historically attracted investment capital post WWII. Japan’s bubble economy came to a frothy head between 1986 and 1990, when short-term interest rates were lowered from 5% to 2.5%. The subsequent rise of short-term interest rates from 2.5% to 6% by 1991 brought an end to a great run for the Japanese economy.
However, as noted above, we are beginning to see evidence of recovery in Japan, which is reflected in Japan’s flagship automaker, Toyota’s (TM) position. The weakening yen has been accompanied by an increased level of investment in Japan since 2012, and should this trend continue, Toyota’s competitors, like General Motors (GM) can face growing competition from Japan. The remaining articles in this series focus on how Japan is showing signs of investment recovery with its new economic policies coming into play, and consider the future prospects for automakers such as Toyota (TM) and Japan’s export economy in general.
For more detailed analysis of the overall Japanese economy, read Bank of Japan Tankan supports a 2014 equity rally in Japan.
The Bank of Japan & zero interest rate policy
Twenty three years have passed without a single cycle of the monetary policy tightening in Japan. Short-term interest rates have remained near 0% since 1996. The above graph reflects what has happened with regard to the decline in investment in Japan since 1990. Japan’s post-bubble investment decline and strengthening currency placed a tremendous burden on Japan’s exporters and domestic economy in general. The following commentary focuses on how an investment recovery in Japan can change this long-term trend, and provide a more profitable operating environment for Japan’s exporters like Toyota.
Japan’s lost decade
Economists have referred to the 1990’s as Japan’s “lost decade.” This expression was used to capture the overall decline of Japan, as explained by a decade of lost opportunity in terms of implementing meaningful structural reform in a declining economy. If only bad economics came discreetly packed in decade-long increments! As the yellow line above reflects, Japan saw its last investment hurrah between 1986 and 1990, and things have gone downhill ever since. The question remains, what can Japan do about growing investment once again? Japan’s new Prime Minister, Shinzo Abe has some radical ideas that have rattled Japan’s slumbering equity markets, and drastically weakened Japan’s currency since his election in November 2012.
Abenomics: Larger budget deficits and an aggressive monetary policy
Japan’s new Prime Minister, Shinzo Abe in conjunction with Bank of Japan Governor, Haruhiko Kuroda, will attempt to end the post-1990 deflationary spiral, which has gripped the Japanese economy. These policies, known as “Abenomics,” will attempt to encourage private investment through a more aggressive mix of monetary and fiscal policy. Abenomics aims to end deflation by targeting a 2% rate of inflation, as well as to increase fiscal spending by 2% of gross domestic product (GDP). This level of government spending raised the 2013 deficit to a whopping 9.2% of GDP in 2013. The U.S. saw this deficit reach 12.1% in 2010, although it’s now within 4.0% of GDP, while Japan is within 5% of GDP, but appears to have a harder time managing this deficit than the U.S.
China took a bit out of Japan Inc.
As the above graph reflects, the entry of China onto the global economic stage of free market capitalism has led to “A Great Exodus” of capital formation. Foreign direct investment began to pour into China post 1976, as Deng Xiaoping’s Open Door Policy began to develop. China began to suck in capital from around the world, as manufacturers such as Toyota rushed to mothball factories in high cost G-7 countries such as Japan, and build new, state of the art manufacturing centers in China’s new Special Economic Zones. However, with the rapid rate of acceleration in China’s wages versus Japan’s, this post-1990 secular trend could be headed for change. If the Japanese yen weakens another 20% over the next year, manufacturers like Toyota can look forward to adding to domestic production, and in turn, add to their lead over both production and profitability over competitors like GM.
Japan’s equity outlook
As 2014 progresses, investors may see a continued outperformance of Wisdom Tree Japan Hedged (DXJ) and the iShares MSCI Japan ETF (EWJ) versus China’s iShares FTSE China 25 Index Fund (FXI) and Korea’s iShares MSCI South Korea Capped Index Fund (EWY). For further clarification as to why DXJ may outperform both EWJ and the other Asian equity indices, read Why Japanese ETF’s outperform Chinese and Korean ETF’s on Abenomics. Plus, as Japan pursues unprecedented monetary expansion, and the U.S. Fed tapers its bond purchases, Japanese equities can also outperform broad U.S. equity indices, as reflected in the State Street Global Advisors S&P 500 SPDR (SPY), State Street Global Advisors Dow Jones Index SPDR (DIA), and Blackrock iShares S&P 500 Index (IVV).
For more on how the U.S. Fed’s recent announcements could impact global equities, read Will the Fed take a bite out of Apple?