Recessionary fears in Japan stoke investor anxiety
The Japanese economy is in all sorts of trouble, staring down the barrel of a second successive quarter of negative growth. Weak domestic demand coupled with a China slowdown has derailed the ‘Abenomics’ stimulus policy. In response the Bank of Japan has promised to maintain its policy of monetary expansion valued at ¥80 trillion per annum.
Overall, policymakers are in agreement that a Japanese recovery is on the cards – albeit at a moderate pace. Japan is plagued by China weakness, falling domestic demand and an economic slowdown in emerging market countries across the world. As such, production and exports from Japan are falling. This is reflected in recent economic data.
The Bank of Japan policy board decided by a margin of 8-1 that it would continue to purchase real estate investment trusts and exchange-traded funds, to inject additional liquidity into the economy. The October statement from the Bank of Japan was bullish about the growth in advanced economies, and bearish about the slowdown in EM economies.
Industrial production and exports are lower as indicated, due to weak global demand as a result of the Chinese equities meltdown. Major mining corporations across Europe and North America are also feeling the pinch as multi-year low commodity prices coupled with a strong US dollar are hurting the industry.
Accommodative economic measures are being adopted, and despite deflationary pressures, the Bank of Japan is confident that inflation will rise over the long term. The recovery process is expected to take time, and the core consumer price index is currently down 0.1% year-on-year, owing to weakness in the energy sector (oil and natural gas).
The economic well-being of Japan is precariously balanced since emerging market economies are under tremendous pressure. Accommodative policies across Europe, the prospect of a Fed rate hike in the US, and an EM currency slump are lining up to create additional anxiety for traders. For now, it is clear that the Bank of Japan intends to aggressively pursue its QQE policy (quantitative and qualitative easing) with a 2% inflation target in mind.
No additional stimulus for now
Many economists are of the opinion that Japan’s accommodative monetary policies are not rooted in reality. The structural cracks in the Chinese economy have yet to fully impact on EM countries in respect of commodities, debt and foreign exchange holdings.
The longer China weakness continues, the worse the situation becomes for the global economy. Japan is particularly vulnerable since it relies heavily on trade with China and EM economies for its well-being. On Wednesday 30 September the BoJ rejected an expansion of the current stimulus policy. However, on October 30 the BoJ will likely feel increasing pressure to adopt further monetary easing measures to kick-start the Japanese economy.
By purchasing real estate investment trusts and exchange-traded funds, the BoJ will continue to inject much-needed liquidity into the market. Monetary policy has remained stable since the stimulus was announced in October 2014. As an investor, it will be important to see how the BoJ reacts in its October 30 meeting. If no decision is made to increase accommodative policies, it will appear the BoJ is less committed to reaching its inflation target. In other words, bullish sentiment will decline and this will likely impact on equity prices on the TSE.
That the BoJ has cut the production forecast for the economy is important to bear in mind. Over the course of the summer, industrial production declined and excess capacity in Q2 increased. These grim realities point to an economy that is quickly going off-course.
An important ratio used by the BoJ compares the economy’s available resources and how they are used: that number declined to -0.73% between April and June 2015, from +0.19% during January and March 2015. The 1.2% shrinkage experienced by the Japanese economy between April and June has had a detrimental effect on equities and investments in the island nation. Any time there is excess capacity, it indicates that inflation targets are not within range.
How investors should react to the Japan situation
It is likely that the Governor of the BoJ, Haruhiko Kuroda, and policymakers will reduce their price and growth projections at the next meeting. This will temper expectations among investors.
During August, machinery orders plunged by 5.7% much to the surprise of economists and government officials. Consequently, Japanese companies are delaying their investments in production facilities and slowing down manufacturing to deal with declining demand. Perhaps the best indicator of the pulse of the nation is Japanese worker sentiment. This metric plunged from 49.3 in August to 47.5 in September. Recall that figures below 50 are indicative of contractionary economies.
As an investor, you would not be heartened by the BoJ Governor’s call for wage increases at this juncture. Should that happen, equity prices will plunge on the TSE. Big business simply isn’t in a position to increase wages to help the BoJ reach its inflation target of 2%.
Traders must acknowledge that Japan has entered a period of technical recession. After industrial production plunged by 0.6% in July, it fell by 0.5% in August. The annualised contraction in the Japanese economy is now at 1%. Japanese gross domestic product is likely to plunge on the back of successive quarters of economic contraction. There is increasing urgency among the political elite in Japan to implement urgent fiscal stimulus policies in addition to expansionary monetary policies. However, the BoJ is sticking to its guns with regard to the ¥80 trillion per annum monetary easing policy.
There are some signs that the Japanese economy could be turning the corner:
- Wages are increasing
- Unemployment has declined
- Inflation is increasing albeit at a lower rate
The problem with the Japanese economy is the fiscal measure in the form of a consumption tax hike. With more of a burden being placed on consumers, accommodative monetary policies are necessitated. Demand is weak and production numbers are tapering off. The Bank of Japan could adopt further measures to influence public expectations regarding inflation, such as making additional asset purchases and giving the general public an indication as to exactly how long it wishes to maintain accommodative policies.
As an outsider with an interest in Japanese stocks or the economy, the only clarity is that we are wading through murky waters right now. Anxiety will increase in the days leading up to the next BoJ meeting, but persistent commodities weakness will all but rule out any signs of a recovery in Japan.
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