Japan marches to the beat of a different drummer. And its pace, slow and steady, is looking solid as much of the rest of the world contends with the din of roaring inflation and clanging recession.
Japan's economy has now increased for three straight quarters, with a 1.1% increase year-on-year in Q2 GDP, and is finally back above its pre-Covid levels. Its slow progress requires no shock central-bank interventions; there's sticker shock at the till that prices are rising at all, in a nation used to deflation, but inflation is running at a mild and manageable 2.4% as of July.
"We have to admit that this [recovery to Q4 2019 levels] looks late compared with the mid-2021 returns marked in the U.S. and the Eurozone," Nomura's chief economist for Japan, Kyohei Morita, says in a note to clients. But it is a "sustained recovery in growth over several years," with the Japanese bank anticipating growth of 1.5% for 2022, 1.4% in 2023 and 1.4% in 2024.
It's normally Japan that is flitting in and out of recession, but it's the Western world and even China that are now wrestling with that bear. Japanese stocks are far steadier as a result, with the broad Topix of all major listings in Tokyo down only 1.6% year-to-date, and up 3.8% over the last 12 months.
Even after a strong recovery from June lows, the Nasdaq composite is down 17.2% in 2022, and 10.6% over the last year. The S&P, likewise, is down 10.2% so far this year, and 3.2% in the red since this time last year.
It would be ironic if it takes a pandemic to cure Japan of its economic ills. But the inflation that has been induced to head-spinning levels in the West has instead brought an increase in Japanese prices that is actually welcome, in terms of economics if not the home front. The central bank governor was forced in June to apologize for saying that the pandemic has led to "improvements" in the tolerance of price increases by consumers. But in a strictly economic sense - as opposed to home economics - he is right. It is good that prices, and hopefully wages, and corporate spending, should start to rise instead of declining, the deflationary spiral that has gripped Japan for a quarter-century.
And indeed, the decent Q2 figures put out by Japan's Cabinet Office this week were driven by increases in private consumption, private capex, and exports. The headline figure was lower than expected because private inventory investment produced a drag on growth. Still, the Q2 growth of 1.1% came in stronger than the 0.7% achieved in Q1.
Wages need to increase further. Morita points out that, at the home economics level, the "goods" that most households have to sell are their labor; the seller's price is per-capita wages. The cost of production, meanwhile, is the cost of living: prices.
So a household's terms of trade equate to per-capita consumption per worker divided by prices. That calculation still shows a sharp deterioration in Q2, down 1.6% quarter-on-quarter. Wages shifted into reverse for Q2, down 1.2% year on year after a decent 15 months of growth. Companies, however, and the national terms of trade are suffering an even-sharper downfall, generated in part by the depreciation in the yen, which increases costs for imports.
Private consumption is still increasing, with consumer spending accelerating from quarter-on-quarter growth of 0.3% in Q1 to 1.1% in Q2. Some of that spending may be forced due to higher prices, particularly for energy and fuel since Japan imports all of its oil. But inflation isn't expected to accelerate from here; in fact, Nomura sees it sinking back to 0.8% in 2023 and leaving prices flat at 0.0% in 2024.
The government would still like to see steady inflation of around 2%, hoping that will stimulate sectors right across the economy. Consistent wage growth would be particularly welcome. Households and companies alike are compulsive savers in Japan so "forcing" spending by promising that prices will go up next week/month/year would encourage them to spend.
Morita and his team think "deflation is unlikely to return," with a moderate recovery driven through 2024 driven by solid spending on services, wage growth, post-pandemic reopening, and rising investment in the digital economy. The Bank of Japan, also out of step with the rest of the world's central banks, is unlikely to change its loose monetary policy before 2025 at the earliest, with "steady state" inflation not yet achieved.
Japanese equities therefore continue to justify themselves as safe havens. An ETF like market-share leader iShares MSCI Japan ETF (EWJ) or the yen-hedged WisdomTree Japan Hedged Equity Fund (DXJ) offer diversification at a time other developed-world markets are on shaky ground.
