by Milton Ezrati, Lord Abbett
Japan still looks troubled. To be sure, the economy recorded a surprisingly strong 4.1% annualized real gross domestic product (GDP) growth in the first quarter. Much of that growth, though, was due to government spending. Otherwise, the flow of news still points to the same tepid growth that has troubled Japan for more than 20 years now. Four of the last six quarters have shown real declines, including last year’s fourth quarter. This once-powerful exporter faces a deficit on its balance of international payments, while spring data releases show industrial production in decline. The country also continues to face the threat of deflation. Consumer prices have only risen because of past fuel price hikes. Now that the cost of a barrel of oil has declined, Japan will likely again see aggregate price declines. The Nikkei stock market1 has not missed the point, either. It has fallen some 15% since April. The recent downgrade reflects in part on this economic picture. Still, there are opportunities.
Commentators popularly have identified four proximate causes for Japan’s relapse into weakness. Most obvious is the lingering effect of 2011’s earthquake and tsunami. These have left Japan with only four of its 54 nuclear power reactors in operation, constraining industrial capacities generally and forcing a 25% increase in fossil fuel imports. Both the recession in Europe and severe flooding in Thailand have hurt Japan’s critical export sector. Most important is the rise in Japan’s yen, which has gained almost 40% against the dollar and even more against the euro since 2007. The initial upward move in the yen occurred because Japan was seen as a haven during the 2008–09 financial turmoil. More recently, the yen has offered a haven from the uncertainties of Europe’s sovereign debt crisis. Whatever the cause, though, the yen’s rise has hurt Japan’s export performance and has encouraged a greater reliance on imports.
But there also is something more fundamental holding Japan back, as it has for more than 20 years now. The advancing average age of Japan’s population is a part of that problem. Japan has already reached a point where it has barely over three people of working age for each citizen older than 65 years. Such a shortage of working hands and minds, especially relative to a huge, dependent group of retirees, cannot help but hold back the pace of growth. Making the problem worse, Japan, in all this time, has failed to adjust its economic model for this demographic reality. The economic emphasis remains on manufacturing for export. No nation can stay the workshop of the world, as Japan once was and still strives to be, when so much of its population has reached retirement age, especially when surrounded by the youthful, eager, cheaper labor populations elsewhere in Asia. No doubt Japan would do better if today’s particular problems were to lift. But even so, the economy would still face these fundamental constraints, as it has for two decades when other particulars have lifted.
For all this less than inspiring economic reality, however, opportunities still present themselves in Japan. Unlike the government in Tokyo, many Japanese companies—global, regional, and local—have made insightful adjustments. They have outsourced simpler jobs elsewhere in Asia and to other continents even as they have retained in Japan those usually high-end aspects of business at which the county still excels. They have built marketing, production, and sales operations in faster-growing areas of the globe, emerging economies, Australia, and North America. But because these companies are headquartered in Japan, their stock prices have remained depressed, despite their adjustments. They have been tarred, so to speak, with the same brush that has depressed stock prices in general. That circumstance has left an opportunity to buy, at very good prices indeed, quality companies that have found ways to sidestep Japan’s problems even as they use its remaining advantages. If it is still too early for broad Japanese investments, matters clearly are ripe for judicious stock picking.
1The Nikkei 225 Stock Average is the leading and most-respected index of Japanese stocks. It is a price-weighted index comprised of Japan's top 225 blue-chip companies on the Tokyo Stock Exchange.
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