Japan's Stock Market Breakout Based on a Solid Foundation
(Bloomberg View) -- Some of us have waited a quarter of a century for this. The Japanese stock market has finally pierced the “iron coffin lid” otherwise known as 1,800 on the benchmark Topix index. There have been four failed breakouts since Japan’s stock market bubble collapsed in 1990. Each time the reversal was quick and nasty, leading to lower lows and deep recessions.
With markets you never say never. External shocks, whether financial or geopolitical, can derail positive trends in an instant. Yet this time the market’s underpinnings look much more solid. Indeed, the Topix is lagging several other Japanese indexes. If it had kept pace with the Jasdaq Index of smaller, higher-growth stocks this century, it would be closing in on 3,000!
Crucially, the better mood amongst investors is validated by the surge in corporate profitability and the better performance of the Japanese economy as a whole. Government data on Friday showed that the economy expanded at a faster-than-expected 2.5 percent rate in the three months ended Sept. 30, marking seven straight quarters of growth and the longest expansion since the mid-1990s. This is a remarkable turnaround, given Japan’s reputation as economic basket case and imminent financial disaster zone of interest only to short-sellers.
These days Japan is starting to look like a model case in the management of an aging, mature society. Over the past five years, Japan’s growth in real gross domestic product per capita has exceeded the average for both the Group of Seven and the Organization for Economic Cooperation and Development. Even more striking has been the sharp improvement in nominal GDP, which had not grown at all the previous 20 years.
What did not happen is as important as what did. There has been no upsurge in populism or protectionist sentiment. Policy makers and big business have not sought to stimulate growth through mass immigration. Politics has been stable, with Prime Minister Shinzo Abe on course to become Japan’s longest-serving political leader since the dawn of the parliamentary system in the 1880s.
Abe’s success has been built on pragmatic, pro-growth macroeconomic policy, with monetary policy super-easy and less emphasis on austerity. Hyperventilating about the level of public debt -- once almost as popular among Japanese officials as macro hedge fund managers -- has gone out of fashion. The ratio of public debt to GDP has been falling due to an increase in the denominator.
Small reforms such as the loosening of visa requirements for Asian tourists have had big consequences. Visitor arrivals were 5 million at the beginning of this century. This year the number will be 28 million and the government’s long-term target of 60 million looks feasible, though an enormous infrastructure build-out will be required to support those numbers.
A nudge toward better corporate governance has paid dividends. Most eye-catching of all has been the increase in jobs, driven by the influx of women and, to some extent, retirees into the labor force. The result has been a surge in the employment rate of the 15- to 64-year-old workforce, taking it to the highest level of any large country in the OECD.
This transformation has happened with remarkable speed. Japan is simply not the same as it was five years ago.
Five year growth in nominal GDP
Topix five-year total return
Topix earnings per share
Tankan survey of business conditions
Growth in full-time jobs (latest, yoy)
Foreign visitors (previous 12 months)
Tokyo office vacancy rate
Tax revenues (general account billion yen, last 12 months)
Female employment rate (15-64)
% of Topix companies with >2 independent directors
It may seem strange to talk of an economy where 26 percent of the population is over 65 as “running hot,” but that is exactly what is happening. The temperature could and should rise further. Japan’s labor market is as tight as a taiko drum, with the offers-to-applicants ratio at a 40-year high and the ratio for full time employees above 1 for the first time ever. The result is likely to be higher wages and higher inflation over the next few years, though not enough to push the Bank of Japan into tapering. As real interest rates fall, reflation will get more traction.
If wages rise, wouldn't that squeeze corporate margins? Not necessarily. It is quite possible that as human capital becomes more expensive, managements will use it more efficiently and margins could even expand. We know this can happen because it already has in the first sector in Japan to experience serious labor shortages and much higher wages: the construction sector. Profit margins here have shot up to a 60-year high.
More capital investment, better use of IT systems, more mergers and acquisitions and spin-offs, greater willingness to exit unprofitable businesses -- these are some of the likely consequences of Japan’s long-term labor shortage. In other words, a stealth restructuring of the economy driven not by government fiat but by organic economic processes. The prospect of such a scenario could support significantly higher stock prices and leave the “iron coffin lid” rusting in the graveyard.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Peter Tasker is an author and founding partner of Arcus Investment, a fund management firm specializing in Japan.
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