Will the Yen Bears Be Surprised?

It is now very clear that the inflation/recession scare in mid-2006 was over done. Consumer prices have since been generally well-behaved, while GDP growth expectations are being revised upward in the US, the Euro area, and now Japan.

If the Economist Poll of economic forecasters for February is any indication, there is still significant potential for upside surprises in Japan's economy, as forecasters had been revising their 2007 growth expectations for Japan downward while US and Euro area growth expectations are being revised upward.

This implies the potential for a Japan "growth scare" to at least temporarily shake out some of the yen bears, even if the BOJ does not move on rates this week or in the foreseeable future.

In our opinion, current views on Japanese personal consumption are too bearish as they are based on faulty Japanese consumption statistics. Japan is currently experiencing one of the tightest labor markets in decades, which will inevitably push up wages from 2007~2008. Moreover, the first wave of retirements by baby boomers (equal to some 8.6% of the labor force) is distorting reported average wage numbers downward.

The GDP surprise has revived interest in the banks and in retail. However, it is an unjustified leap of faith to assume that stronger top-down fundamentals will translate into bank stock and retail stock rallies in equal measure, as demographics, global competition and polarization continue to exert strong pressure for continued consolidation and M&A in these areas.

Among the megabanks, on the earnings fundamentals of the trust banks (such as Sumitomo Trust) are moderately positive. On the other hand, while investors welcome the ongoing consolidation in the department stores with merger talks between Daimaru and Matsuzakaya, department stores as a whole continue to be plagued by adverse demographics, competition from online sales and a proliferation of high-end suburban super malls being operated by real estate developers such as Mitsui Fudosan.

Disclosure: The author is long EWJ.

Comments

[Lance:]

I would add some comments about Japanese personal consumption:

Yes, the labor market is "tight". No, this "tight" labor market is not leading to rising levels of consumer spending, or even higher salaries, except in those rare areas where indeed very specialized skills are in short supply. Here, in fact, is the primary dynamic at work:

1) In most cases, when you reach age 60 here, both you and your bloated salary are out the door. Yes, there has been some movement to retain workers beyond the mandatory retirement age, but the percentage of workers retained is paltry. And even when they are retained, in many cases they take a pay cut.

2) Far more people reach age 60 in Japan every day than reach age 20.

3) The people hired at a young age, by and large, work for peanuts compared to the people who are near retirement. Naturally, this presents a logical reason for companies to move glacially when it comes to retaining high-salary older workers versus exchanging them for low-salary young adults. If you want to please stockholders, you dump the 60-year-olds in a heartbeat and replace them with 20-somethings that will work for 25 to 33 percent of their salaries. In a globalized market, you in fact have little other choice.

4) Much of job growth in Japan is coming at the "Would you like fries with that?" end of the salary spectrum.

5) Every year, pensioners see their benefits chipped away at. They receive smaller cash payments, and their co-payments for things like health services increase.

Does any of this sound like a country that is set to begin a consumer spending binge?

None of this is to suggest that Japanese corporations will not continue to show improving earnings, and corporations that make money tend to support equity markets and currencies.

But companies that depend on so-called "domestic demand" in a very mature economy, in a country with a shrinking population, and in a country in which huge pools of very cheap globalized labor are just one time zone away, are not likely to become the growth engines of the future. Expectations of suddenly explosive Japanese consumer consumption are a good story for the currency and equity markets, but whether that story turns out to be fact or fiction is another matter.

2007 Feb 20 06:06 PM

[Darrel Whitten:]

The point is not whether Japan is on the verge of a "consumer spending binge", but whether consumer is actually stronger (and potential GDP growth) is actually stronger than was indicated in the weak Q3 GDP number, and whether the apparent strength in Q4 GDP was real or a statistical fluke. In other words, Japan's sustainable GDP growth looks better than the weak Q3, but not as strong as indicated by the Q4 number (i.e., real GDP growth is more like 2.5%).

There is ample evidence that Japan's labor market is tight, and that this is more than a shift from retiring baby boomers with full benefits to "burger flipping" younger workers. Moreover, the government's household survey is notorious for distorting underlying consumption trends, while further distortion is being added by the wave of retiring baby boomers, i.e., the 60-ish part of the labor force.

Thirdly, a GDP surprise for Japan does not require a so-called "consumer spending binge". All is required for a "growth scare" is firmer consumption that currently overly-bearish assumptions assume, which is implied in the comments about domestic demand in a mature (i.e., ex-growth) economy. After all, if currency traders could believe that the end of quantitative easing and a modest tightening of short-term rates by the BOJ (i.e., the end of ZIRP) could destroy the current climate of global excess liquidity (and the fundamentals behind the yen carry trade) with the stroke of a pen, they are just as gullible about an ostensible re-appraisal of Japan's potential growth rate and the implications this may have on BOJ policy.

2007 Feb 25 04:06 AM