Artemis: Four investment myths about Japan
With Japan having announced a long-awaited programme of aggressive easing policies this morning, Artemis Global Select manager Simon Edelsten details four myths about investing in the country.
For years there’s been no money made from investing in Japan. So why bother?
This problem often arises from charts showing the performance of the Nikkei. Normally it’s shown in yen, thus negating the small matter of the yen’s strength over the last decade. If you had invested in the Nikkei in sterling, it would have performed much like the S&P or the FTSE All-Share.
There have been two lost decades of stagnation.
We have no rebuttal for the 90s, but since 2000 Japan has delivered growth in GDP per capita similar to that of other developed countries. GDP in Japan has not changed, but then neither has the population. GDP increased by a fraction in the west, but populations have grown by almost 10%.
Japan is the world’s most indebted economy.
This is not a myth. Gross debt is $13.6 trillion and rising. That’s 236% of GDP. But the country has substantial financial assets (such as gold), and so the IMF revises the previous figure down to 117% of GDP – which is still on the high side. Why do the credit-rating agencies not award Japan a rank lower than AA-? Firstly, it can print its own currency to pay its bills.
Secondly, this level of debt has been affordable. As interest rates are very low, the charge to service the debt only amounts to 1.2% of GDP. The US has a similar cost of 1.7%, the UK’s expense is 3.4% and for Italy it’s 10%. Although debt may be more affordable in Japan, as any hedge fund manager knows, a low net debt exposure ay look comfortable – but you’re very vulnerable if the cost of your gross debt rises.
At the moment the opposite is happening. The vast bulk of the government’s debt, JGBs, is held domestically. The high indebtedness of the Japanese state is mirrored somewhat by the high liquidity of the household and, more recently, corporate sectors.
Many are puzzled by Japanese pensioners’ willingness to hold JGBs, which are yielding 0.55% today. Japan’s most recent CPI was -0.2%, so that gives you a risk-free rate of a whopping 0.75%.
The obvious conclusion is that Japanese pensioners don’t like risk. A UK pensioner holding a 10-year gilt is being paid 1.85% currently. But our CPI number in February came out at 2.8%, giving a real return of -0.95%. Perhaps Japanese pensioners have a point. Trends in both countries are, of course, for all of the above to get worse – and indeed they have been (getting worse.)
Taxes have risen, particularly collectable taxes such as those concerning sales. In the UK, VAT has been increased to 20%. The outgoing Japanese government passed a bill that will raise sales tax from 5% to 8% and up to 10% in a couple of years, so their ability to service their debt is improving.
If you’re wondering, the basic state pension in Japan is about the same as in the UK at £5,500, but most Japanese workers have a funded company scheme too. This pays a lump sum at retirement which the recipients then invest themselves. The US system is different, but average social security works out at £7,500 per claimant.
Prime Minister Abe won’t last any longer than his predecessors.
While the LDP ruled Japan for many years, its leaders seldom lasted long. The DJP – which toppled the LDP in 2009’s election – had improved their credibility by gaining defecting LDP politicians after Abe-san’s disastrous year as prime minister in 2006-7 – a term which ended in a bout of ulcers.
Many aspects of the ‘new LDP’ seem thoroughly unreformed – nationalistic and addicted to special interest groups and ‘pork barrel’ politics. But aspects of the victory in December seem different. It was a landslide: the LDP alone has 294 of the 480 seats. The election for the upper house (the half of the members elected in 2007 when the DJP was still credible) is to be held in July of this year.
So far Abe’s popularity remains unscathed, despite the aforementioned hikes in sales tax and a rushed application to join the Trans- Pacific Partnership. This latter point may require significant tariff reductions in Japan, threatening the highly protected agricultural sector – a staunch centre of LDP support.
So will Abe-nomics work?
We don’t think anyone has to answer that question. It seems certain that there will be plentiful asset purchases. This may well weaken the yen (which is cheap for us to hedge), though it’s tough to choose a currency to hedge into during the ‘world’s ugliest currency competition’.
QE may raise inflation above zero, but further than that is a long-odds bet and some stocks may have risen to levels where this is counted as a certainty.
A more likely outcome is that the QE drives asset prices higher as it has in previous episodes. Japan seems different from other countries, but the laws of business still operate. Like anywhere else, good companies with strong finances tend to deliver – whether politicians do or not.