By one definition – two consecutive quarters of GDP contraction – Japan’s economy unexpectedly entered recession in the third quarter of this year. After some initial turbulence, markets have generally responded with broad indifference. Nonetheless, the news has stimulated a fair bit of hand-wringing among some commentators on whether this is the moment we must all accept the failure of Abenomics.
For us, that sort of speculation is at least premature. The main factors on which the biggest negative surprise was focused were business inventories (as a sub-component of business investment) and personal consumption. But if we look at the long-term history of these components’ contribution to Japanese GDP, the third quarter change (circled in red on the chart below) hardly looks significant. In fact, if we excluded the business investment component, GDP would have actually expanded by 1% over the third quarter. This is despite the fact this business investment figure is of a level that would have come out in the wash in most other quarters. Furthermore, the particular focus on the change in inventories as the driver seems to be over-analysis, since ‘inventory’ as a category tends to be measured only indirectly anyway, as a residual of another calculation.
Meanwhile, personal consumption rose less than expected, quarter-on-quarter, seemingly as a result of consumers still struggling with April’s sales tax increase. However, comparing with the response in this component in the second quarter (see chart above), makes the impact of the tax hike already look likely to be short-lived. The next expected tax hike has already been postponed.
Looking more broadly at the Japanese economic outlook, the picture over the past twelve months has actually been quite encouraging. The weak yen has seen prices consistently positive for the first time in many years, and although wages have not really kept up, there is essentially full employment in Japan. In the corporate sector profits have surprised on the upside and there has been a fairly healthy level of dividend growth. So there are reasons for optimism that could be positive for Japanese equity markets. In our view, the long-term facts don’t support a weaker outlook. But as always, commentators can usually find something to fix on in the short term data to support their views, whether they are in bullish or bearish mood.
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