The first is consumption. The bull case here is that consumption should, at least in the near term, pick up. Japan has been relatively slow in reopening from Covid compared to Europe and the US (particularly in opening its borders), and there is an assumption that consumption could be strong in the first half of this year, especially given the renewed ability for travellers to visit from China. Our view is that such an outcome is plausible, but is likely to be short-lived. Looking out over the medium to long-term the consumption picture for Japan is more difficult, chiefly due to demographics. As investors in Japanese equities, this leads us to avoid the leisure and retail sectors – which could bring a little pain over the next few months, but in the fullness of time we firmly believe it will prove the right approach.
The second topic is the state of the global economic cycle, and whether there will be a full-blooded global recession. Macroeconomic data is trending in a negative direction, but how bad will it get? Japan is home to a lot of cyclical companies and so what happens to growth elsewhere in the world matters a great deal. From a contrarian viewpoint, however, the amount of fretting that markets have already done about growth has created some compelling entry points in certain cyclical stocks, in our view. So those are opportunities we’re exploring selectively.
Lastly, we come to the big one: monetary policy. The Bank of Japan (BoJ) caught everyone by surprise when it tightened policy in December, but it’s worth remembering that this was a very marginal move from a base of extremely loose policy. The impact of monetary policy on the real economy is lower in Japan than it is for other developed markets, due to the lack of indebtedness in both business and households. When businesses are deciding whether to invest or households whether to spend they don’t typically need to raise debt in order to do so, such are the levels of cash savings, and therefore the cost of borrowing moving slightly in one direction or another is a less meaningful factor in that equation.
The current period of inflation (which stands at around 4% in Japan, which is high by its standards but way below other developed economies) offers the Bank of Japan the opportunity to take a step towards normalising policy, by loosening the straightjacket of ‘yield curve control’ on the government bond yield just a little bit. At its latest meeting this week it maintained the policy, despite some speculation that it would either widen the yield curve control bands further, or scrap them altogether. This demonstrates a core principle that applies to interpreting the BoJ’s actions in relation to those of other central banks. Elsewhere, central bankers are inflation fighters who worry about inflation getting out of control, with price inflation leading to second order effects in the labour market. For the BoJ it is quite different, however – they worry about the absence of second order effects, that wages won’t rise and that inflation will peter out and they will be back where they started. We can’t blame them – the trauma of deflation lives long in their memories, and recent data has shown real incomes hammered. That is not to say that the BoJ won’t continue to normalise policy, it probably will, but just that it seems to us an overreach to argue it will go faster or further than the market expects. Boring as it is, we think more likely that the BoJ will continue to be cautious.
How we’re dealing with this from an investment point of view is by trying to avoid it as a risk factor wherever possible, or hedging that risk by adding to positions in stocks that could benefit from higher rates (e.g. banks). But that is something we’re doing at the margin rather than completing reorientating our strategy around the pronouncements of the Bank of Japan. Yes, monetary policy matters, of course, but in our view it’s more of an obsession for Japanese market participants right now than it probably should be.
The value of active minds: independent thinking
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