From the end of October diners at Yoshinoya, Japan’s leading gyudon or beef bowl restaurant – a favourite of salarymen and visiting fund managers alike – are in for a nasty surprise. Not gastronomically, for the food is sure to be as delectable as ever, but financially as the price of a medium sized bowl of beef-topped rice has been increased for the first time in seven years by fully ten percent to the still staggeringly cheap ¥426. Coffee drinkers can expect a bigger jolt than usual with Nestle upping prices of fifty-six coffee products by ten to twenty percent. Meanwhile, crisp enthusiasts are also going to suffer with Calbee announcing a combination of price hikes and reductions in serving size.1
These anecdotes, whilst Japanese, tell a global story of crimped supply and surging demand. And whilst households worldwide are being squeezed by higher prices, nowhere is this feeling more alien than in Japan where inflation is but a dim memory for most. But is this the beginning of a generally inflationary period for Japan, or just a sector-level spasm? And what are the implications for investors either way?
The current situation is that overall inflation is still very muted, but this is because prices are being restrained by big reductions in mobile phone tariffs, a phenomenon unlikely to continue indefinitely. Certainly, surveys show that households are expecting more inflationary pressure to come2 but it should be noted that they always fear the worst and are usually wrong.
Last month Bank of Japan Governor Kuroda expressed his disappointment that inflation was not higher, blaming the corporate sector for soaking up higher costs without passing them on, saying “Businesses have been unable to break the habit they acquired during the deflationary period”.3
Clearly, he thinks that Yoshinoya, Nestle and Calbee are the exceptions rather than the new inflationary rule. Consequently, market expectations are for Japanese government bond yields to increase only very slightly whilst much higher rates are forecast in other developed regions.4
The result of the above is that real – inflation adjusted – yields might decline in Japan versus other regions, a prospect which has seen macro-focused investors selling the yen. A less abstract reason for the recent weakness in the yen is that, as the prices of imported products such as food and commodities rise, more is needed to be converted into foreign currency to pay for them so driving down the value of the Japanese yen.
As frequent readers of these pieces will know, we are reluctant to make short-term macro calls and genuinely phobic of investing on the back of them. However, against this backdrop of rising input costs and questionable transmission into consumer prices it seems prudent to focus upon companies which can do that best. The importance of genuine competitive advantages and pricing power should not be underestimated, and to be underweight many of the heaviest users of increasingly expensive inputs, and the manufacturers of minimally differentiated manufactured products feels right to us.
The flip-side of our aversion to short-term macro fortune-telling is our full acceptance that we should invest with, rather than against, super-macro realities. These realities include the related trinity of an ageing domestic population, sluggish household consumption and flat if not negative pricing. Is it time to “revise our priors” with respect to the latter?
Maybe, but probably not. Japan’s ageing population is still a huge factor – as people move into the most aged cohort, they consume less. Whilst this does not guarantee the absence of inflation it does suppress what classical economists refer to as the velocity of money, a key component (in their view) in the inflationary equation.
Another factor is wages. We have written before about the structural tightness of the labour market – how Japan’s ongoing demographic shift has turned labour from a plentiful resource into a scarce one. The real head-scratcher here is why wage increases have been so miserly – base wage inflation has been substantially below one percent for almost all of the last two decades despite shortage conditions for the latter part of that.
One major reason is that Japanese unions have been so hopeless at extracting the kind of wage hikes their members deserve, which in turn could be down to the fear that increasingly expensive regular employees would be replaced by non-regular ones – part-timers and temps. This concern is not entirely without foundation.
It is possible that unions spontaneously grow a spine, or that non-regular penetration – driven by increased female participation – ebbs, or even that new PM Kishida’s mooted policies to incentivise pay rises through tax breaks will finally lead to meaningful wage inflation which could filter through to CPI.5 We remain open minded, but these possibilities still rate more as hope than expectation.
Overall, it is clear that global inflationary pressures can be seen in Japan. It would be odd if they were entirely absent. As things stand this is primarily a cost issue with transmission through to price still extremely patchy. Consumers will be feeling it, and indeed are expecting it, but that doesn’t mean that profits won’t get squeezed too. Investors in price takers beware, we will seek out price makers wherever we can. The situation is murkier the further out we look. For sure there is a plausible route to more generalised sustained inflation in Japan, but given the deeply engrained pricing inertia, demographic headwinds and dislocated labour market it seems more likely that this route remains untaken.
2 Source: UBS, Japan Macro Watch, November 2021, Inflation expectation one year forward
3 Nikkei, October 2021, Weak yen is ‘positive’ for Japan’s economy: BOJ Kuroda – Nikkei Asia
4 Source: CLSA, Benthos, Yen going south for winter, October 2021
5 Reuters, October 2021, Japan’s Kishida puts wage hike incentives ahead of higher capital gains tax | Reuters
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