Atlantic International Partnership Headlines:Japanese economy more important than it seems

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Even in an age of global diversification, Japan is one big economy that gets scarcely any respect from investors. Maybe that should change.
This, at least, is the contention of Peter Berezin, a managing editor of Montreal’s Bank Credit Analyst investment publication.
Berezin, who formerly worked as an economist for Goldman Sachs and the International Monetary Fund, is quite aware of Japan’s long, lamentable record of deflation and stock-market disappointments. Over the past decade, Japan’s Nikkei 225 index has lost fully 30 per cent of its value. Over this same period, Canada’s commodity-fuelled S&P/TSX index has gained 75 per cent.
Indeed, he joked Monday, “the bar for upside surprises is pretty low.”
But this, of course, can be quite a good thing in the investment world. If good news is not a surprise, then it’s already priced into an investment.
That’s certainly not the case in Japan. Investors are less than impressed with the outlook for a country whose economy has been in a coma for two decades, struggling to recover from big real estate and stock bubbles that imploded at the end of the 1980s. Indeed, nominal GDP hasn’t grown since 1990, Berezin notes, and the country’s future is clouded by the developed world’s heaviest debt load and an aging workforce that’s actually shrinking year after year.
Japan’s credit rating reflects these awful trends. Although it’s a rich country that is home to many of the world’s most successful multinational corporations, Japan has seemed unable to take control of its enormous national debt.
As a result, its credit rating was cut in January to AA-, three notches below that of Canada or the U.S. There’s even the risk that it could be cut again, this time because of hefty new borrowing to fund an estimated $300 billion in reconstruction needed after the massive earthquake and tsunami that struck in March.
But to an experienced eye, all this doom and gloom has actually accomplished some encouraging things.
A key one, Berezin points out, is that after many years of bloodletting, Japanese stocks are “dirt cheap.” That cuts the room for any more disappointments and increases the odds that earnings and prices will hold pleasant surprises in the future.
This is certainly not a get-rich-quick trading opportunity, since national turnarounds don’t happen overnight. But for investors who are content to prosper more slowly, Berezin believes Japan will be a better-than-average place to park some money over the coming five years.
For good things to happen, of course, there will need to be more than merely the attractive starting point of cheap equities. There must be a solution to the government-debt problem as well as some sustained growth in the economy.
The debt problem, while big, isn’t nearly as intractable as one might think, Berezin notes. All that’s required is political will.
Nearly all government debt is owned by Japanese, so there’s no spectre of foreign investors going on strike, and the country has an enormous stock of foreign assets offsetting much of this debt. As well, the government pension system is well funded, removing one financial stress that’s serious in many other countries. Finally, Japanese taxes are among the lowest of any industrial country, leaving room for tax hikes, if needed.
Happily, there are signs that economic growth is finally headed for a sustainable recovery, which should both ease the debt problem and tend to boost asset values.
Wage deflation, which has long held back the spending power of consumers, seems to be coming to an end, with some growth in pay since early last year. Reinforcing this, consumers and corporations have little debt and the banking system is much healthier than it was during the years when it was crushed by bad loans. This suggests there’s room for credit growth to boost spending.
Another big plus is that Japan is well-positioned in the fastest growing region of the world, with the biggest chunk of its exports headed for the emerging economies of Asia. For example, points out Berezin, the U.S. is no longer its biggest export market; China is.
Of course, even with a growing list of positives, one might fear that Japanese officialdom could snatch defeat from the jaws of victory, just as it seemed to do with earlier economic blunders.
“In economics, there is always a temptation to draw moralistic conclusions from the performance of national economies,” Berezin wrote in a recent note to clients, and Japan’s policy mistakes over the years provided ample grist for such moralizers. But this is overdone.
Japan has also suffered from plenty of bad fortune. “The Japanese economy has staged four major recoveries over the past 20 years and all four have been sabotaged by shocks over which it had little control,” he said, pointing to the Asian financial crisis, the market’s tech crash, the subprime crisis that spread around the world and this year’s exceptionally destructive earthquake and tsunami.
There could always be yet another shock or another policy blunder — most notably, failing to rein in government debt — and even without these, Japan will never be a fast-growth economy.
But with all of its negatives already priced into the market, while few seem to expect a return to normal growth, Japan now looks like a more attractive place for investors than you’d think.