Stock investors rediscovering Japan these last two years are suddenly being reminded why they stayed away so long.
Asia’s No. 2 economy has been on a tear with global investors thanks to an unlikely “safe haven” halo. Despite underwhelming national growth, flatlining wage growth and the globe’s worst debt burden, Japan stacked up favorably to an inflation-wracked U.S., a Covid-lockdown-plagued China and a lethargic Europe.
The Bank of Japan, meantime, has generally remained in easing mode as the vast majority of global central banks tighten. Warren Buffett making his first-ever big Japan bets in late 2020 sure didn’t hurt. Those headlines alone had Japanese assets going viral in global financial circles.
With the Nikkei Stock Average hitting 30-year highs this year, Prime Minister Fumio Kishida had one job: signal that the reforms on which investors are betting are in the works. Even better, put an actual upgrade or two on the scoreboard to validate investors’ bullishness.
Kishida hasn’t delivered. In his first two years in office, he failed to implement any phase of his “new capitalism” strategy to increase incomes and catalyze a startup boom. Since taking the top job in October 2021, Kishida hasn’t resurrected any of the repairs promised by his mentor, the late Shinzo Abe.
From 2012 to 2020, Prime Minister Abe pledged to cut bureaucracy, modernize labor markets, rekindle innovation, incentivize youngsters to take risks, empower women and reclaim Tokyo’s place as a top financial center. Mostly, Abe prodded the Bank of Japan to add extra firepower to the quantitative easing off which Japan has lived since 2001.
Abe’s government did have one notable win: encouraging companies to strengthen governance and improve returns on equity. Yet without other policy changes, all Abe did was prove that trickle-down economics still doesn’t work. Most CEOs haven’t shared profits with workers.
Kishida sought to regain the reformist momentum for his Liberal Democratic Party. To no avail, which helps explain why his approval ratings are around 28%, the worst of his tenure. And why Japan’s big stock rally shows signs of stalling out.
Some investors are even wondering if China’s bruised stock market might now be a better bet than Japan’s. The rationale: Beijing’s efforts to boost the economy via assertive fiscal and monetary stimulus will revive the globe’s worst-performing major stock market. Mainland equity valuations, it’s worth noting, are at historic lows.
Japan, by contrast, faces intensifying headwinds from abroad as its biggest trading partners slow. It’s importing inflation amid rising commodities prices faster than Tokyo expected. And now the BOJ is under pressure to close the gap with rising U.S. bond yields.
Any tweak to QE policies that have become the respiratory system of a $4.3 trillion economy will choke off economic growth and upend the calculus on Nikkei and Topix index shares. Suddenly, investors must confront the reality that free BOJ cash did the most to propel Tokyo stocks higher, not some supply-side revolution.
Again, Kishida could’ve avoided another Wile E. Coyote moment in Japan. He could’ve used the last 764 days to recalibrate growth engines, level playing fields and build economic muscle. Yet Kishida, like his myriad predecessors over the last two decades, is punting on financial upgrades.
The real mistake that Japanese government after government makes is thinking time is on Tokyo’s side. It’s not. For all China’s daunting challenges, its arrival as a trading superpower has sped up Asia’s economic clock. Complacency in Tokyo, Seoul or Jakarta just makes it easier for Xi Jinping’s economy to increase its regional dominance.
Now that his approval ratings are in the danger zone from which governments don’t tend to survive, it’s not clear how much political capital Kishida has to raise Japan’s competitive game. This realization could be the next proverbial shoe to drop for global asset managers.
“Global funds are highly exposed to Japanese equities, much more so than in the last decade,” says Herald van der Linde, a strategist at HSBC Holdings. “So, there’s limited room to increase their holdings.”
That might be as true of Berkshire Hathaway’s Buffett as anyone. Even the “Oracle of Omaha” upping his bets couldn’t mask the many challenges racing Japan’s way. It hardly helps that economists are bracing for Japan’s next recession. A growing number of economists think Asia’s No. 2 economy contracted in the July-September quarter following growth of 4.8% in April-June period.
In 2018, the BOJ’s balance sheet topped Japan’s annual gross domestic product, a first for a Group of Seven economy. How much more can Governor Kazuo Ueda’s team do to ensure any recession is a mild one? Especially considering the yen is already near 33-year lows.
Kishida’s team is racing to roll out Tokyo’s latest stimulus package—this one totaling 17 trillion yen ($113 billion). Here, too, it’s unclear that will be sufficient to offset the loss of Chinese demand for Japanese goods.
If Japan has any prayer of maintaining its safe haven halo, Kishida’s government must act urgently and boldly to remind investors why they gave Japan another try. Sadly, time is not on Tokyo’s side.