Japan Macro Memo The Case For Japan
Japan stands at a major inflection point. After more than a decade of stagnation, a new structural up-cycle is starting to emerge. Merrill Lynch forecast that Yen asset markets - equities and real estate - are poised to be both an important leading indicator and virtuous stabilizer in the coming Japan structural up-cycle. This time, the cycle is for real because:
1. Concrete Corporate Restructuring Success
Corporate Japan is much better than its reputation. Operating profits of listed companies rose to Y23.9 trillion (about US$210 billion) in FY3/2003. This is 20% above the 1990 previous historic high. For investors, the key implication of the newfound focus on profitability is that Japanese shares have become cheap. For example, the Nikkei is now trading on less than 20-times earnings (compared to a long-run average of around 40 times).
2. Domestic Demand Recovery
On top of strong exports, Japan's domestic demand is now kicking-in as an engine for growth. Business investment rising already and the consumer outlook is now improving: For the first time in over three years, incomes are now rising and the unemployment rate is falling.
3. Extraordinary Pro-Growth Monetary Policy
Since the new Bank of Japan Governor team took office in March, Japan's monetary policy has become hyper-inflationary: the central bank is buying stocks, is directly lending to small/medium-sized companies and is buying almost 40% of the treasuries' annual bond issuance.
4. Decisive and Pro-Active Bank Bad Asset Policy
Bad asset policy has also changed for the better. The aggressive use of public funds to nationalize a major money center bank plus public-funds assisted corporate revitalization for borrowers (via the newly established IRCJ) indicates that the cost of the bad asset workout will be born by the taxpayer, rather than shareholders.
5. Sayonara Deflation - "Cold Money" Turning "Hot"
Mobilization of the extraordinarily high liquid balances - currency in circulation is now 15% of GDP, up from a historically stable 7% - could quickly close the demand/supply deflation gap. Once expectations turn from deflation to inflation the power of "cold money" turning "hot" could drive up prices and demand very fast. Although unpredictable in size and timing, this record Yen liquidity pool suggests Yen asset markets are poised to significantly overshoot current fair-value estimates.