The trouble with Japan

Japan has problems but, compared with what is going on in Europe, these are old, well known and therefore the arguments runs, not such a problem.

To begin with, it has an aging population – Japan’s population will have shrunk to 95m by 2050 down from 120m now. There are many implications because of this, notably a shrinking workforce and rising pension and healthcare costs.

Then there is the debt problem. Government debt is 200 per cent of GDP, which is higher than Ireland, Greece and Italy.

Investors, however, seem comforted by the fact that most of the funding is domestic, which is fine until the economy can no longer fund it. Some estimates suggest there could be just four-to-five years of domestic funding left. Once this runs out, the Japanese government has to turn to overseas investors and it is unlikely they will be happy with a 1 per cent return from an economy so weighed down with debt.

The final problem is deflation, which has been persistent within Japan’s economy for many years and results in consumers putting off consumption today because it will be cheaper tomorrow – but why does Japan suffer from deflation?

At the moment, the rest of the world is concerned about rising prices driven by higher energy costs, higher commodity costs and higher food prices, so why does all this upward pricing pressure by-pass Japan?

I have asked this question of Japanese fund managers many times and have yet to really piece it together. It seems to be a combination of 'once entrenched it is hard to break'; that property prices have fallen by more than 80 per cent in some instances; and that related costs, such as home furnishings, have fallen in price too.

The food sector in Japan has been opened up to competition, where previously polices had protected home industries. I gather that vegetables are now cheaper than they were in the late 1980s and of course the currency has been strong, slowly appreciating over time, which has boosted buying power and reduced the cost of imported goods.

The Japanese government is trying to boost the economy and hopes to get house prices rising as a means to create modest inflation. Mortgages fixed for 10 years at 1 per cent are available along with tax refunds worth up to £3,500pa on property purchases. Child benefit worth £100 a month has been introduced, as have "eco-points", a voucher system to encourage spending on a wide range of goods.

Another positive is that economic production since the earthquake has been much better than analysts forecast and companies are expected to deliver good results for the six month to September. One of the major concerns was the potential lack of energy: only 19 out of 54 nuclear reactors are operating. Energy consumption, however, has fallen by 15 per cent thanks to a concerted effort by businesses and individuals. As a result there has been no power shortage.

Japanese fund managers are obviously buying stocks and not the economy per-se and there is a broad consensus that they can find good value in high-quality companies that are out of favour because Japan is out of favour.

They also say that a lot of Japanese companies are not performing well, they may have cash on the balance sheet (but no plans to spend it) and the return on equity (ROE) is very poor, all of which is compounded because companies lack focus to change this situation. Furthermore companies that were once world leaders have lost their edge, such as Sony.

For the value in these stocks to be realised there needs to be new investors and these almost certainly have to be foreigners because the domestic investor remains inactive and is likely to be so going forward. Even with a yield of 2 per cent on the Topix index the domestic investor who is desperate for income still stays away, preferring to invest in bonds or overseas markets. As for which fund to invest in, FE Trustnet’s data shows, over one year, a wide range of returns from +44 per cent to -1 per cent, so pick carefully.

It seems that Japan will continue to struggle economically and that making profitable returns from the stock market is possible but not without its challenges. Japan's weight of economic problems will over-shadow the stock market for many years yet.

Perhaps there is a glimpse here of the future for debt-laden Western economies, because we’re not as smart as we like to think we are when it comes to managing economies – just look at Europe and the US.

Tim Cockerill is head of collectives research at Ashcourt Rowan. The views expressed here are his own.