Japan Emerges as a Surprise Growth Market
(Bloomberg) -- Japan isn’t exactly the most obvious place to open a family theme park. Over the past six years, as the country’s epic demographic crisis has intensified, the number of children has plunged by 1 million. Yet on April 1 hundreds of fidgety kids and their dutiful parents withstood spring showers to attend the grand opening of the world’s newest Legoland.
As you’d expect, the $380 million-plus project—built on former industrial land in Nagoya, Japan’s third-largest metropolis—possesses the requisite miniature town assembled from Lego bricks, not to mention amusement rides and water slides. What’s more surprising is when, during a visit, Nick Varney, chief executive officer of Legoland theme park developer Merlin Entertainments Plc, calls Japan “one of our three big growth markets”—the other two being the U.S. and China.
Wait, Japan? A growth market? Isn’t this the same Japan where unrelenting demographic trends and stifling economic stagnation have conspired to create the infamous Land of the Lost Decades? Where the failure to achieve a 2 percent inflation target is as predictable as spring cherry blossoms?
Indeed, it is—and indicators that inflation-obsessed investors might have overlooked seem to support Varney’s optimism. The country’s nominal gross domestic product, the calculation that reflects actual yen generated at today’s prices, last year saw its first record high since the 1990s. And corporate profits have hit an all-time high. Lending growth is trending at its strongest since before Japan’s property bubble burst. The unemployment rate is just 2.8 percent, the lowest since 1994. Wages may not be soaring, but they’ve risen more than 1 percent for four straight years—the best streak since the early ’90s—and they jumped 2.2 percent last year. The International Monetary Fund’s medium-term inflation outlook is now 1.6 percent, vs. less than 1 percent in 2012.
Prime Minister Shinzo Abe would be the first to claim credit for putting the economy on a more positive trajectory, and his revamp of the Bank of Japan has played a crucial part. The central bank has pumped massive liquidity for four years now, helping to produce a more competitive exchange rate and to pull down borrowing costs. But Abe has also benefited from some lucky timing. His December 2012 election, for example, coincided with the end of multiple blows to the economy: the early ’90s bubble collapse, the late ’90s Asian financial crisis, an early 2000s bad loan shakeout, and the 2008 global meltdown. Japan’s economy is “not about to grow 4 percent,” says Peter Tasker, who oversees hedge funds at Arcus Investment Ltd. after a career in research at securities firms in Tokyo, “but it can do better than the past two decades, and it can be a successful economy on its own terms.”
Tasker speaks as someone who first planted his feet in Japan in the ’70s, a time when fortunes in his home country (the U.K.) were fading and those of Japan were on the rise. He remembers fondly the bygone era of rapid growth. His take on the ’80s bubble years? “Hell, yeah, that was fun,” he says. Tragically, it was based on “the Godzilla of real estate bubbles,” and inept responses from bureaucrats and bankers to the collapse in asset prices left the economy adrift for decades. But since Abe took office, the political and economic dynamics have changed dramatically, says Tasker, who sees the country as “much more stable.”
While Abe’s record isn’t flawless—a 2014 sales tax rise triggered a recession, and he’s made little progress on job market deregulation—he and his team have had some quality wins besides BOJ stimulus. An initiative to boost the role of women in the workforce has paid off—they account for the vast majority of job gains in recent years. Another achievement: making companies more responsive to shareholders. Dividend increases and share buybacks are at unprecedented levels, asset managers are on the hunt as never before for companies with sleepy boardrooms ripe for shaking up, and investor-relations departments are no longer an oddity.
“This is a much different environment for us as investors,” says Tasker, who regularly meets with representatives of firms that his fund has stakes in. “The idea that there should be a relationship between companies and investors—that wasn’t the case in the ’80s and ’90s.” What it all means for stocks is that Japan is now “in the group of markets that are investable,” he says.
However, positive indicators can’t hide the fact that Japan’s consumption and investment growth rates remain below those of other developed nations. Politicians talk about continuing to battle a “deflationary mindset.” And there’s still the world record level of public debt, more than double the GDP. Above all, many Japan watchers emphasize policymakers’ consistent failure to achieve that 2 percent inflation target. (The last reading, in March, was a paltry 0.2 percent.) But some investors say that’s too narrow a framework. And prices could turn around quickly, if the shrinking supply of labor causes wage gains to accelerate.
Uchida Co., an auto parts molds supplier to Honda Motor Co. founded in 1955, has endured tough times in recent years brought on by Japan’s economic malaise. Executive Managing Director Takumi Tanaka, the company’s No. 2 official, maintains a downbeat attitude. He counts himself as a skeptic of Abenomics from the start, saying in mid-2013 that conditions were even worse than during the post-Lehman Brothers global financial crisis. Four years on, he remains dismissive. “The benefits of Abenomics? Where are they?” he asks, complaining about the length of time it takes to win approval for government subsidies. “We have to find our own way to survive.”
And Uchida has survived. Although it lost a factory to Japan’s devastating 2011 tsunami and continues to endure pressure from its customers, revenue is projected to rise by one-third this year compared with 2012. Tanaka credits his company’s success to technological advances, including 300 million yen ($2.6 million) in machinery investment over the past two years. Uchida is investing another 300 million yen in the fiscal year starting in June. And it’s added 10 full-time employees since the 2011 quake, bringing the payroll to 105 people. “We just have to keep trying and investing in technology in order to make business in Japan,” Tanaka says.
Bigger fish, too, are thriving, despite Japan’s challenging fundamentals. East Japan Railway Co., the country’s largest passenger rail operator, has warned for years that a falling population would undermine its long-term business. Yet JR East, as it’s known, has seen its revenue climb to record levels. As with Uchida, investment is one reason—a bigger network for its bullet trains has boosted sales. New lines from Tokyo to the Sea of Japan and the northern island of Hokkaido have led to a “big increase” in travel, according to the company’s president, Tetsuro Tomita. “There’s also been a significant impact from inbound tourism,” he told reporters at an April briefing. “We’re working to take better advantage of it to increase sales.”
Tourism numbers have soared so high that the Abe administration had to reset its targets. Some 24 million visitors arrived in Japan in 2016, blowing through Abe’s original goal of 20 million by 2020, the year Tokyo will host the Summer Olympics. Hotel investment is booming to accommodate the influx, and local communities are vying to offer their particular attractions—world-class skiing in Nagano, swimming with dolphins off Miyake Island, hiking near volcanoes on the southern island of Kyushu. “Japan’s tourism industry is on the verge of becoming a major economic engine for the country,” analysts at McKinsey & Co. wrote in an October report. A swelling middle class in emerging-market Asian economies including China and Thailand has propelled the boom, with fellow Asians lured by Japan’s reputation for customer service, food quality, efficient transportation networks, and beautiful scenery.
There’s plenty of room for growth: Tourist receipts amount to just 0.6 percent of GDP, less than half the U.S. ratio and little more than one quarter of France’s, according to 2015 World Bank data, the latest available.
One thing Japan seemingly can’t escape is population decline, and its enduring opposition to large-scale immigration means the number of workers is bound to plummet. But there’s a new dynamic that can help it manage that process: automation. Abe’s government calls it “the robot revolution.” Two of the world’s top-four industrial robot makers, Fanuc Corp. and Yaskawa Electric Corp., are based in Japan, and when it comes to services, the potential for growth is seen as enormous. The development and deployment of robots and artificial intelligence is projected to save 5.7 million Japanese jobs through March 2031, according to an economy ministry estimate.
Abe, who’s scheduled to stay in power at least until late 2018 (and potentially through 2021, assuming his party wins the next election), continues to pursue reforms, including a recalibration of trade policy now that President Trump has pulled out of the regional Trans-Pacific Partnership. “There’s been far more success for the overall Abenomics agenda than generally recognized,” says Jonathan Garner, chief Asia and emerging-markets equity strategist at Morgan Stanley in Hong Kong, who has Japan as one of his top market picks. He anticipates both nominal growth and wages to strengthen further, finally spurring inflation—“the last piece of the jigsaw puzzle to fall into place.”
So is it morning in Japan again? That would probably be overstating things. “I’ve never come across a country which talks itself down as much as Japan,” says Varney, the Legoland developer. “It’s still a remarkable success story.”
So, finally, the sun may have at least stopped setting.
Anstey covers Asian cross-asset markets for Bloomberg News in Tokyo. Ujikane covers the economy in Tokyo. With Yuki Hagiwara, Chris Cooper, and Henry Hoenig
To contact the authors of this story: Chris Anstey in Tokyo at firstname.lastname@example.org, Keiko Ujikane in Tokyo at email@example.com.