Total gross investment
The below graph reflects the changes in capital formation in Japan. As with fixed capital formation in the prior graph, gross capital formation, as shown below, has been on a long-term downward trend, even when it seemed to be on the path to recovery from 2003-2008, until the global financial crisis hit. Now that the 2008 crisis has passed, and the yen has weakened dramatically since 2012, Japan is seeing gross capital formation growth rates surpass levels unseen since 1996.
The below graph reflects the historical net shrinkage of investment and capital base of Japan. However, there is plenty of room for upside growth in investment, should the yen continue to weaken, and the domestic economy begin to recover on export growth. In other words, the current recovery in growth rates reflects the bounce from the low base effect related to years of weak investment data and a very strong yen. This article considers the recovery in Japan’s investment data and the implications for domestic exporters such as Toyota (TM).
For more detailed analysis of the overall Japanese economy, read Bank of Japan Tankan supports a 2014 equity rally in Japan.
What is gross capital formation and why is it important?
Gross capital formation consists of outlays on additions to the fixed assets of the economy plus net changes in the level of inventories. Such items include commercial and industrial buildings, roads, hospitals, schools and private housing. As noted in the fourth part of this series, China has been involved in a massive build out of its manufacturing and industrial base since 1978, as reflected in the dramatic growth in its gross capital formation. In contrast to China, Japan, being a more mature economy, has seen declines in this area of the economy post-1990, even when it seems to be recovering fairly strongly since 2012.
Strong yen and strong China slowed Japan’s investments, although not forever
The dramatic growth in China’s capital formation reflects a country entering a major phase of development. In contrast to China’s birth as a freer market economy stands Japan’s decline as a mature economy. As the above graph reflects, Japan has had little need to build new factories or acquire new equipment at a rate in excess of historical rates since 1996, although recent data reflects that this trend is slowing or reversing.
As shown in the fourth graph in this series, Japan seems to have hit its investment peak around 1990. By that time, Japan had finished building out the foundation of its post WWII manufacturing base. However, as the yen has weakened from 76 to over 100 against the U.S. dollar since 2012, these trends have begun to change. In Japan, new economic growth in a wide array of manufacturing had simply wound down, or failed to grow. Such are the symptoms of a mature economy with limited growth prospects. However, change may be on the way in the form of “Abenomics,” and perhaps there is the possibility that the above trend line can reflect accelerating growth in the future as the yen continues to weaken.
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?