Originally published in Bloomberg Prophets column 12/12/2017. The opinions expressed are those of the author.
Some of us have been waiting a quarter of a century for this.
The Japanese stock market is on the verge of piercing the “iron coffin lid,” namely the 1800 level on the Topix Index. There have been four failed breakouts since Japan’s stock market bubble collapsed in 1990. Each time the reversal was quick and savage, leading to lower lows and deep recessions.
With markets you never say never. External shocks, whether financial or geopolitical, can derail positive trends in a trice. Yet this time the market’s underpinnings look much more solid than on previous attempts. Indeed, the Topix itself is lagging several other Japanese indices. If it had kept pace with the Jasdaq Index of smaller growthier stocks this century, it would be closing in on 3,000!
Crucially, the better mood amongst investors is validated by the surge in corporate Japan’s profitability and the better performance of the Japanese economy as a whole. This is a remarkable turnaround, given Japan’s previous reputation as economic basket-case and imminent financial disaster zone of interest only to short-sellers.
These days Japan looks more like a model case in the management of an ageing, mature society. Over the past five years, Japan’s growth in real GDP per capita has exceeded the average for both the G7 and the OECD as a whole. Even more striking has been the sharp improvement in nominal GDP, which had not grown at all for the previous twenty 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 macro-economic policy settings, with monetary policy super-easy and less emphasis on austerity. Hyper-ventilating about the level of public debt – once almost as popular amongst Japanese officials as macro hedge fund managers – has gone out of fashion. The public-debt-to GDP ratio 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 eminently feasible- though an enormous infrastructure build-out will be required to support those numbers.
A nudge approach to better corporate governance has quite literally 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 labour force. The result has been a surge in the employment rate of the 15-64 year old workforce, taking it to the highest level of any large country in the OECD.
The cliché about Japan is that change is “glacial,” if it comes at all – yet this transformation has happened with remarkable speed. Japan is quite simply not the same place as it was five years ago.
|December 2012||December 2017|
|5 year growth in nominal GDP||-7%||+11%|
|Topix 5 year total return||-40%||+150%|
|Topix earnings per share||33||111|
|Tankan survey of business conditions||-9||+16|
|Growth in full-time jobs (latest, yoy)||-0.3%||+2.7%|
|Wage growth for part-timers||+0.2%||+2.5%|
|Foreign visitors (previous 12 months)||8.4 million||27.3 million|
|Tokyo office vacancy rate||8.8%||3.0%|
|Tax revenues (general account, last 12 months)||33.2 trillion||55.6 trillion|
|Female employment rate (15-64)||61.0%||67.7%|
|Topix companies with >2 independent directors||17%||85%|
|Suicides (latest full year data)||30,651||20,984|
It may seem strange to talk of an economy where 26% of the population is over 65 as “running hot”, but that is exactly what is happening. Real growth in GDP has exceeded the potential rate for seven quarters in a row. And the temperature could and should rise further.
Japan’s labour 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 over 1x for the first time ever. The result is likely to be higher wages and, ultimately, higher inflation over the next few years, though not enough to push the Bank of Japan into tapering.
If wages rise, would that not 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 labour shortages and spiralling wages – the construction sector. Here profit margins 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 labour 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 than we have now and leave the iron coffin lid where it belongs -rusting in the graveyard.