Japan among hardest hit by global crash

Oct 21 2009 by Andrew Miller, The Journal

ALTHOUGH the global economy seems to have escaped a depression, it’s clear that the slowdown experienced last year and early this has done considerable damage to many of the world’s leading economies.

Japan stands out as one of the main losers in this regard and we expect real GDP to slump -5.6% this year, compared to a contraction of around -2.0% globally.

In common with several other regions, Japan’s economy turned up in the second quarter of 2009, with real GDP expanding by 0.6% quarter-on-quarter. This was mainly driven by three factors: the pick-up in external demand, sharp inventory adjustments and domestic stimulus.

However, while the up-trend in exports should continue over the next several quarters (largely because the outlook for the US and China looks favourable), the prospects for private consumption in Japan look more uncertain.

Indeed, employment and income conditions have continued to deteriorate, making the pick-up in household spending hard to sustain.

New government policy, however, may help to boost consumption again next year. All in all, we expect real Japanese GDP to continue expanding in Q3 and Q4, but the current recovery will probably lose some momentum by the beginning of next year.

We believe that some key growth drivers are still weak and need to improve to put Japan on a sustainable growth path. This is especially true of employment.

Private investment has also failed to pick up so far, despite the recovery in exports and production since March.

In our view, high spare capacity will continue to sustain the deflationary trend in Japan, probably until mid-2011. Furthermore, some of the measures announced by the government, such as the elimination of highway tolls and the abolition of provisional tax rates, could push consumer prices even lower.

Investors considering Japanese equities as a play on global recovery should not ignore these deflationary risks. However, on a short-term view, we believe that an actively managed portfolio of Japanese equities offers a cost-effective way of gaining access to growth in Asia, particularly as Japan has lagged the broader Asian equity market indices by a very considerable margin this year.

For its part, the Bank of Japan has recently grown more optimistic on the Japanese economic and financial outlook, although we do not see a quick exit from its current policy stance.

More initiatives, such as quantitative easing, may be needed to help move out of deflation.

On the political front, the Lower House election saw the historic victory of the opposition Democratic Party of Japan (DPJ) over the ruling Liberal Democratic Party that had governed for all but 10 months since 1955. DPJ economic policy focuses on boosting household income (via the introduction of a child allowance for example), but this will be partly offset by sharp cuts in public investment. The overall impact should therefore be limited.

However, a completely new government may rouse “animal spirits” in the Japanese stock market and provide a short-term boost.

In all, Japan has been something of a laggard both in economic and stock market terms this year, and there are no easy or quick fixes.

But, for those investors who want cheaper access to Asia, a portfolio of select stocks could be attractive.

Andrew Miller is director of Barclays Wealth in Newcastle