Lately, it seems as if no asset class, country nor business sector is safe from the bear market (a relative Teddy bear so far, but a bear nonetheless). As we wait for the turmoil to subside, we’re constantly evaluating where we think our clients’ assets are best positioned going forward. Lately, Japan has been of particular interest to us.
20+ years of economic purgatory
Soon after its real estate and stock market bubbles burst in 1989, Japan became caught in a deflationary spiral. While most major countries have seen their GDP’s expand over the past 20 years, Japan’s has actually contracted slightly over this period (see chart below).
[While some European GDP data is incomplete above, you can see how much more these countries’ GDPs grew compared to Japan.]
Japan’s declining GDP over the period can be explained in large part by persistent deflation. While most investors fear inflation, deflation is far more crippling because it discourages consumers from buying: Why purchase something now when it is likely to be cheaper in the future?
Not surprisingly, weak economic performance has led to poor earnings growth for Japanese companies, causing Japan’s equity market to actually decline over the past 20 years:
[EWJ = Japanese stocks; SPY = US stocks; EWC = Canadian stocks; EWL = Swiss stocks; EWG = German stocks]
Waking a sleeping giant
With the world focused on China (now the second largest economy after the US), we tend to forget that Japan is number three and was in second place as recently as 2010. But over the past two decades, while most developed and emerging economies (especially China) grew handsomely, Japan stagnated—its economy and stock market went nowhere.
Since 2001, the Bank of Japan (BOJ) has tried to stimulate the Japanese economy using quantitative easing and other measures, to limited success. In December 2012, Shinzo Abe became prime minister of Japan on a platform of economic reforms. “Abenomics” included quantitative easing on a scale never before seen in Japan or elsewhere, along with various fiscal measures. The ultimate goal is to bring an end to deflation and help the Land of the Rising Sun again live up to its name.
While it’s too soon to declare victory, Abenomics has finally produced some inflation in both prices and wages, dramatically weakened the Yen (important for a net exporter like Japan), and buoyed consumer spending. As a result, Japan is finally seeing some persistent growth in GDP, though still slow compared with other major countries.
Last month, the BOJ instituted negative interest rates, joining the ECB and a few other central banks. So long as the BOJ and the Abe government persist in their efforts, we think it’s likely that these policies will continue to increase Japanese consumer spending and bank lending. Moreover, there are many other reasons to be bullish on Japan, including one of the highest rates of R&D (research and development) spending as a percentage of GDP in the world[i], surging corporate profits and returns on equity, investor-friendly corporate reforms, rising dividends, and increased demand for stocks from both the Japanese public and institutions[ii]. Moreover, the combination of high productivity and a weak Yen makes Japan one of the most competitive locations for manufacturing in the world.
Don’t call it a comeback—yet
It’s still too early to say that Japan will again become an economic titan, but the events of the past three years suggest that the country’s economy is finally emerging from its economic purgatory. And with equity valuations the cheapest they have been in decades, we see a lot of upside here. We continue to modestly overweight Japan in our client portfolios, and are constantly looking for companies there that will benefit from the country’s recovering mojo.
Please let us know if you have any questions, comments or requests for future newsletters.
Dr. Ken Waltzer, MD, MPH, AIF®, CFA, CFP®
Managing Director, KCS Wealth Advisory
Laura Gilman, CFP®, PFP, MBA
Managing Director, KCS Wealth Advisory
Adam Bragman, CFA
Director of Investment Research, KCS Wealth Advisory
KCS Wealth Advisory is a registered investment adviser. Our services include discretionary management of individual and institutional investment accounts, along with personalized financial, estate and tax planning services.
Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Past performance does not guarantee future results. Investing involves risk, including loss of principal. Consult your financial professional before making any investment decision. Other methods may produce different results, and the results for different periods may vary depending upon market conditions and portfolio composition. This email does not represent an offer to buy or sell securities.
Investment advisory services offered through KCS Wealth Advisory, an SEC Registered Investment Adviser. Clearing, custody services and other brokerage services provided to clients of KCS Wealth Advisory are offered by Fidelity Brokerage Services LLC, Member NYSE/SIPC. Fidelity and KCS Wealth Advisory are unaffiliated entities. When securities are being offered, they are offered through Mutual Securities, Inc., Member FINRA/SIPC. Supervisory office located at 807-A Camarillo Springs Road, Camarillo, CA 93012. KCS Wealth Advisory is not affiliated with Mutual Securities, Inc.
Electronic communications are not necessarily confidential and may not be delivered or received reliably. Therefore, do not send orders to buy or sell securities or other instructions related to your accounts via e-mail. The material contained herein is confidential and intended for the addressed recipient. If you are not the intended recipient for this message, any review, dissemination, distribution or duplication of this email is strictly prohibited. Please contact the sender immediately if you have received this message in error.