This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, J.P. Morgan Asset Management Global Market Strategist Kerry Craig gives his view on what to make of the recent Japan economic data and the potential investment implications.
Abenomics is yet to create the expectations for sustainable long-term growth that Prime Minister Shinzo Abe so desperately wants, but this doesn’t mean Japan can’t be a source of return for investors in the near term.
Markets were growing wary that Japan would not extend quantitative easing
The Japanese economy only expanded by 1.0% on an annualised basis in the last three months of 2013, well below the expectations of 2.8% growth and down from approximate 4% annualised growth over the first half of last year. Despite the slowdown, domestic demand remained in relatively good shape, growing by 3.2% and recording the fourth consecutive quarter of 3%-plus growth. Some of the pullback in the fourth quarter figure was due to large inventory build ups in prior quarters being paid back. Inventory build up and drawdown wax and wane from one quarter to the next and should be excluded when trying to decipher what is really driving growth.
Of more concern was the negative impact of the export market on the latest growth figures, as exports were soft and imports surged. Slower growth in exports has partly been blamed on weak demand from emerging countries, which are the destination for a surprisingly high proportion of Japanese goods. Meanwhile, Japan has become heavily reliant on energy imports since the closure of its nuclear power plants, causing the spike in imports. However, Abe is making noise about restarting the reactors which would curb the imports of natural gas.
The result of the weaker-than-expected export market has been a sharp deterioration in the country’s trade balance. A record deficit of JPY 11.47 trillion was recorded in 2013, far outweighing any money flowing into Japan and creating a current account deficit. The long-term implication of a sustained current account deficit is that Japan would become dependent on external financing, which would be extremely costly given that the level of government debt already stands at 240% of GDP.
In the near term, however, continued strong policy support from the government and the Bank of Japan (BoJ) should mean the economy continues to maintain a better growth path. The consumption tax rise planned for April will probably cause a dip in growth in the second quarter, but the government hopes that by directing ministries to spend the bulk of their budgets in the first half the year, it can continue to support growth and offset any slowdown by consumers.
Until recently, markets were growing increasingly wary that the BoJ would not extend its quantitative easing (QE) programme, as its forecasts for growth and inflation were quite optimistic and inflation was heading towards the 2.0% target. However, the recent poorer economic data and the likely impact of the consumption tax increase have put the possibility of more easing firmly back on the table.
Further easing may not come until after the April tax hike, but the BoJ is employing other measures in advance as it attempts to mitigate the effects of the hike and support markets by any measure. The growth-supporting funding facility was doubled recently, and banks can now borrow JPY 7 trillion for up to four years from the central bank at a negative interest rate (-0.1%). The BoJ hopes this will intensify the transmission effect of the QE programme by giving banks a strong incentive to provide loans.
The economy has softened over the last few months and the tax hike is a big hurdle for Abe to jump. However, in the year or so since Abenomics has been in play, much has changed in the Japanese economy. Household and business sentiment has improved sharply over the past year and more recent survey data suggests continued modest expansion for the economy.
Investors are right to be concerned about the performance of Japan’s exports, and about the long term implications. But in the near term they should remember that, while economic momentum may have slowed recently, the domestic situation is improving and further stimulus from the BoJ is likely. This should provide a boost to markets and further weaken the yen.
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