DISCUSSION

Japan is back as a top global contender

By Jesper Koll

February 27, 2019

Because financial markets are no longer a reflection of the economy, most successful Japan investors ignore domestic developments and instead focus primarily on global economic cycles. | BLOOMBERG

All over the world there are thousands of analysts trying to forecast financial markets based on their predictions for the economy. Unfortunately, most of this is a complete waste of time.

Even if you have perfect foresight of whether growth accelerates or decelerates from one quarter to the next, your portfolio will lose money if you use this as a signal to buy or sell the market in anticipation; and that’s true for almost all markets, no matter whether you buy three months or six months ahead of the economic cycle. Yes, that’s right, you’re significantly better off flipping a coin than listening to economists if you want to make money trading markets through the economic cycles.

Of course, economists are not completely useless. They redeem themselves by having a perfect explanation for the disconnect between financial markets and the national economy — the former no longer reflects the latter. Political leaders like U.S. President Donald Trump and Prime Minister Shinzo Abe — who both have explicitly stated that they view the stock market as the ultimate objective arbiter for the success of their policies — should take note. After all, markets don’t vote; but the citizens of a national economy do.

But back to the problem: Why is it that financial markets are no longer a reflection of the economy? Here, Japan serves as an excellent example of what’s going on. Exports account for about 20 percent of Japan’s GDP, but exporters’ profits now account for 63 percent of all profits for listed companies.

Since markets care first and foremost about profits, this means that Japan’s stock market is basically three times more exposed to, and dependent on, the ups and downs of the global economy than Japan’s GDP. Practically speaking, this is why many of the most successful Japan investors de facto ignore Japanese domestic developments and instead focus primarily on global economic cycles.

Importantly, corporate Japan’s dependence on global profits has gone up since the start of Abenomics: In 2012, only 49 percent of profits were sourced overseas, against the 63 percent we have now. A comparable figure for the United States is approximately 52 percent, a level that’s basically held steady for the past five years.

Where exactly do Japanese profits come from? By region, America still is by far the most important source of corporate profits, with approximately 25 percent of total profits coming from Japanese production made in America or exports from Japan. This is down from approximately 35 percent in the year before the global financial crisis. In contrast, China now accounts for approximately 15 percent, up from 5 percent in 2007. Also up is non-China Asia, now at about 13 percent (from 7 percent). And Europe is down to barely 5 percent (with the remaining 5 percent made up by the Middle East and Latin America).

In many ways, Japan’s high dependency on global developments has turned the Japanese market into a “canary in the coal mine”: Any slowdown or upturn will be picked up very early on by the increasingly dense global networks of corporate Japan. All said, the Japanese market is poised to become an ever more reliable leading indicator for the global economy, while its track record for domestic developments is bound to dwindle further.

Is the rise in global dependence a failure of Abenomics? I don’t think so. I interpret it first and foremost as concrete evidence for the resurgent rise in Japan’s global competitiveness. In fact, most of the increase from 49 percent to 63 percent is due to Japanese service sector companies expanding overseas. Among others, retailers like Aeon, Lawson and Uniqlo have build successful Asian platforms; and most importantly, Japanese banks have become extremely successful at growing their Asian franchises.

In fact, Japan’s three mega-banks have been the biggest lender to non-China Asia for the past three years, with the result that now more than half of the banks’ profitability growth comes from global expansion. By all accounts, this is an amazing turnaround given that barely a decade ago Japanese banks were widely viewed as the worlds’ least competitive financial institutions. All said, the growing global competitiveness and global expansion of the Japanese non-manufacturing and service sector is one of the most interesting, albeit underreported, mega-trends unfolding in Asia.

Importantly, the newfound global expansion of corporate Japan in general, the nonmanufacturing sector in particular, is not a “hollowing out” of the domestic economy. In sharp contrast to what happened during the 1990s, when industrial companies closed domestic plants and drove up unemployment to build overseas factories, the current global expansion of corporate Japan is marked by domestic labor participation rates rising to new historic highs and unemployment falling to new historic lows.

The fact that corporate leaders are investing both at home and abroad tells us that, yes, Japan is back as a top global contender. Japan’s globalization is now based on domestic strength, not domestic weakness like it was during the 1990s. In my book, Japan’s newfound globalization marks a success for Abenomics because it has made Japan strong again both at home and abroad.

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