If investors are looking for a real surprise over the coming year, my suggestion is to focus on events in Japan. The Asian economic powerhouse has been battling not only deflation for a decade but also a host of natural disasters in recent months, all of which have sapped domestic demand. Crucially the government is also valiantly trying to steady government finances and has recently passed a supplementary budget and is expected to pass another in January to support the economy ahead of the next consumption tax hike in 2019. At the same time, the government is (courageously) pushing legislation through the Diet to ease restrictions on foreign workers. And this barrage of policies seems to be having an impact.
According to a recent report from Asia analysts at French bank SocGen, the first round of 4Q data indicates “that economic activity is rebounding after the series of natural disasters that hit Japan over the summer. At the same time, risk-off sentiment is strengthening in the financial markets, stemming mostly from external factors. Newsflow on Japan remains positive as domestic conditions remain strong, despite the ongoing uncertainties in the global economy”.
The chart below – from SG – shows that there’s even some, limited, evidence that the long deflationary funk is possibly coming to an end. Prices are starting to steadily pick up as the labor force shrinks and wages slowly start to rise. Yet despite all this relatively positive news local equity markets have consistently underperformed the Asia and US markets generally, despite a weakening JPY.
One final positive to contemplate. Most other central banks are now starting to tighten aggressively, yet Japan is still the exception. With inflation still well below the 2% target, and bond yields remaining suppressed, the BoJ policy board will probably maintain its monetary easing over the next few months. Might Japanese equities start to stir again?