Dusting Off Japan's Economic Cobwebs

According to Nobel laureate economist Simon Kuznets, there are four categories for the world's economies...

Underdeveloped, developed, Argentina, and Japan.

Argentina is in a group of its own for falling from one of the top 10 wealthiest countries on Earth... to one with persistent sky-high inflation.

Thanks to a government that can't seem to stop printing and spending money, the country has averaged inflation of about 190% over the past 80 years.

And when it comes to Japan... well, we've never seen an economy grow so fast – and then completely stagnate.

Post-World War II, Japan experienced an "economic miracle." Its economy saw rapid and sustained growth of more than 7.5% per year for more than 20 years. It became the second-largest global economy, behind only the U.S.

Then, in the 1970s, Japan's economic growth rate started to decline. It has been in a period of stagnation since 1991.

And because of that, the Japanese market has been nearly uninvestible for more than 30 years.

We've talked before about the country's sleepy stock market... and how its rapidly aging population and ultra-low birth rate are setting the stage for a massive labor shortage.

Now, Japan seems to be at an important turning point. Changes in inflation, interest rates, and wage growth are finally starting to breathe some life back into the economy.

Today, we'll dive into these recent economic changes and what this major shift could mean for investors...

Japan's GDP grew from $91 billion in 1965 to $1.1 trillion by 1980...

The nation focused on innovation, efficient manufacturing, and exports. It became the global hub for industries like consumer electronics and affordable, durable cars.

And the world couldn't get enough of its products. Companies like Panasonic and Toyota Motor (TM) grew to be among the biggest in the world in 1989.

It was a great growth story... until the Japanese stock market peaked in 1989 and the economic bubble burst.

Then, everything took a turn...

The Nikkei 225 Index crashed nearly 60% in a few years. And it barely grew for decades.

Industries like real estate and banking took a beating. Housing prices tanked around the same time the stock market did. Pretty soon, the rest of the economy started struggling.

Over the next decade, a lot of companies couldn't pay their debts, which ended up hurting banks.

However, the nation refused to let companies die. Banks didn't want to force lenders into bankruptcy... So they papered over the losses and kept them barely alive, creating a fleet of "zombie" companies.

This sucked all the innovation and growth out of Japan's economy. It ended up in stasis.

Wage growth slowed, and the government practically halted inflation through rate cuts. Until recently, Japan hadn't raised interest rates since 2007. And since 2016, the country's interest rate was actually negative.

Wage growth has been practically nonexistent. And inflation has hovered near zero – it even had a few years of deflation.

Recently, though, that has all been changing...

Over the past two years, inflation picked back up in earnest. And it started to inject a bit of life into the economy...

Japan's inflation was 2.5% in 2022, and it climbed to just over 3% in 2023... its highest since 1991. For most of the past 30 years, inflation (or deflation) was within 1 percentage point of zero.

This pushed wages to pick up this year, with the nation's biggest companies agreeing to a 5.3% pay hike – once again the largest increase since 1991.

In turn, the Bank of Japan recently decided to end its negative-interest-rate policy. At the end of March, the central bank's policymakers voted to raise the short-term interest rate range to 0% to 0.1%.

It was the country's first rate hike in 17 years – and it's a great show of confidence from policymakers.

It's a sign that they feel the economy is finally growing stronger... and that the country may be ready for a more "normal" monetary policy that allows for a small amount of inflation, positive interest rates, and regular wage growth.

After a 30-year hiatus, Japan finally looks like it's worth investing in again...

The Nikkei 225 even reached a new all-time high this past February.

A little bit of inflation could actually be a good thing for the economy... and if Japan embraces that knowledge, this may be the beginning of a comeback for its stock market.

Japan is still home to powerhouses in the auto, tech, and manufacturing industries – many of which didn't have to do much innovating over the past several years. The economy was that stagnant.

That's about to change. The wheels finally seem to be spinning again... and Japan looks ready to make up for 30 years of treading water.

We expect the Nikkei 225 to show a lot more life for years to come.

Regards,

Joel Litman
May 6, 2024