Does this mark the inevitable return by the Japanese market to terminal decline? Quite the contrary – and we would argue strongly that this time is different. The banking system is very well capitalised; the economy was lifting itself out of deflation even before Kuroda-san at the Bank of Japan started the mammoth quantitative and qualitative easing; the corporate sector has net cash equivalent to 30 per cent of GDP on its balance sheet and has started to invest; the labour market and wages are picking up; and last – and, to be honest, possibly least – Prime Minister Abe really does seem bent on enacting some economic reforms.
Alternatively then, is the recent stock market turbulence a sign that Japan remains nothing more than a play on global growth? If we cannot find domestic reasons for the drop in the market, was it the result of fears over emerging markets? Is this 1997 all over again, when the Japanese market dropped about 25 per cent after the Thai devaluation?
It is commonly held that the transmission mechanism that brought the 1997 crisis to Japan was the banking sector but of course the other important transmission mechanism, both then and now, is trade. Japan’s exports to ASEAN nations fell by almost a third in the year following the Asian crisis and had it not been for the strength of the US economy and the rise in US exports the overall impact on Japan’s trade would have been significant.
Vulnerable markets are stabilising
This time however, the vulnerable markets are not terribly significant for either Japan’s exporters or its banks. There is also little sign of a contagion effect to the markets that are important – ASEAN, China and the US – and in any case, it would appear that the vulnerable markets are stabilising.
Nonetheless, these events are not conducive to reasoned calm, particularly when there are fears over both Chinese and US economic growth. The Chinese authorities are putting pressure on the banking system and this is causing a growth slowdown.
However, Japanese exports to China are continuing to grow strongly, at a year-on-year rate of 11 per cent in USD terms as of December 2013. We believe that the Chinese economy should avoid a hard landing. Fears over the US have been exacerbated by the very poor January ISM figures. The drop to 51.3 from 57 – one of the largest one month falls in recent years and much lower than forecasts of 56 – was met with universal alarm. However, the pertinent question is: what would you expect to see in the ISM for a month in which extreme weather had brought Arctic temperatures and paralysing snowstorms as far south as Texas?
Whether reasonable or not, the market took fright. However, there was no sign of domestic selling. In fact, January saw the largest ever one month inflow into domestic equities by individual investors. The sellers were the foreigners.
At least some part of the foreign investor base believes that Japan is just a play on global growth or alternatively that it will be affected by the problems in Argentina. The domestic investors and this foreign one disagree.