Merrill Lynch's Jesper Koll, "Japan is Back, For Real This Time" 13 comments
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The October edition of the Far Eastern Economic Review features an essay by one of the most well-known Japanese stock analysts, Merrill Lynch's (ticker: MER) Jesper Koll. As I promised this morning, the following is a summary of his reasons why Japan is back as a high-growth economy. Also for those interested in really understanding what's going on in Japan and what to look for going forward, refer to an earlier post of mine covering The Economist's special issue survey edition on Japanese capitalism.
• Koll believes Japan’s economic growth will be closer to 2.5% over the next 5-10 years instead of the 1.0-1.5% that many analysts expect.
• His optimism is based on the large reduction of excesses in corporate debt, capacity, and employment.
• He offers the following reasons why Japan is now free to grow and is no longer as hindered by fundamentals:
- Reduced cross shareholdings
- More competitive resource allocation
- Increased profits – And a recent broadening of profit recovery beyond blue-chips
- Improved balance sheets
• Regarding Japan’s record low interest rates: “Some companies are beginning to scrutinize their capital structures and are starting to lock in record low debt funding to fund new investments without diluting shareholders’ equity.�?
• Companies need to reinvest as factories are aging, now 12-years old on average, which is higher than the historical average of 8-9 years.
• The big drag from Japan’s globalization is over.
• The economic recovery underway is a job-rich recovery.
• Expect a structural upshift in productivity towards 2.8% over the next 5-10 years from current levels of 1.5%.
• Areas of concern: Japan’s overly-complex distribution system. And concern over relations with China in the areas of technology transfers, IP protection, and currency revaluation.
*In closing Koll offered the following upbeat outlook:
The chances of Japan re-emerging as a high-growth industrialized powerhouse are very high. This is based on the tremendously positive private-sector backdrop that has been created by Japan’s private-sector managers. The biggest risk to this scenario would be mismanagement on the part of public-policy makers. So far, Japan’s monetary and fiscal authorities deserve the highest praise for having coordinated their policies with the sole purpose of increasing Japan’s revitalization potential. A premature tightening of either monetary or fiscal policy is always a risk. For now, however, the prospects look good for Japan to once again become a powerful engine of Asia’s growth.
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I'm one of the most skeptical and bearish on Japan but I do think there has been a significant change.
That said, I know for a fact that Japanese companies are still tied to informal keiretsu and do not always go for the cheapest vendor. Relationships are so powerful in Japan they often trump economics.
Thank you for your comments. I understand that you remain skeptical and bearish but it's good to hear you recognize the significant fundamental changes. Koll is not the only long-time Japan analyst calling the current recovery a real one. Robert Alan Feldman of Morgan Stanley Japan has also been increasingly optimistic especially after Koizumi's (and the LDP's) decisive victory in September.
The business culture has undergone profound changes with such legacies as lifetime employment and seniority giving way to merit-based compensation and a rise in the use of headhunters at the top and contracted employees in support positions (although full-time hires are said to be on the increase now). The more powerful and aggressive role of shareholders is also worth noting. Such things as the keiretsu and distribution system still need work but with cross-share holding fading and global competition forcing companies to reconsider their value chains, I believe the informal workings will have less of a restrictive impact on business operations than in the past.
We know the character you mean... the double-right-arrow. Interesting that it's causing you problems - we'll look into it. Thanks for reporting the problem.
I don't feel that Japanese corporations will be able to borrow at extreme low rates going forward. I feel that the Ministry of Finance is reaching its limit in being able to issue notes and bonds at the extreme low rates that we see now. The passage of post office reform will allow individual Japanese savers to shift their investments out of JGB's into higher yielding assets such as US treasuries and corporate debt.
The export industries that Japan has been heavily reliant on now have significant global overcapacity. Steel and consumer electronics are not growth industries for Japan in my view.
I don't see where a big jump in productivity is going to come from given the aging of the workforce.
I appreciate your comments. I do tend to be more optimistic than you. So here are some of my thoughts in reply. Similar to the U.S., healthcare is obviously a major issue in Japan and especially given its age demographics which resemble an inverted pyramid. I am not so sure spending in this area will spur economic growth because of the national health care system in place, hence government subsidies.
I think one of the most important points mentioned in Koll's piece was how companies are seeking to lock in to record low debt funding now in order to make new investments such as in upgrading equipment and plants. This type of investment will certainly improve productivity. You are right in saying that companies won't have these low rates forever, but they will continue to have cheaper access to capital at least for the short-term.
Your point on postal reform and expected cash outflows from JGBs into higher yielding assets is a concern and therefore, we have already witnessed a much more aggressive Bank of Japan marketing JGBs internationally so as to attract more foreign holders. Also, Japan Post is supposed to have begun offering mutual fund investments from October. Nomura will offer two funds, one a mixed or diversified fund consisting of multiple asset classes and the other a Nikkei 225 index fund. Goldman Sachs will offer an enhanced index fund. These fund offerings will fuel domestic investment in domestic securities, a serious stimulus. U.S. treasuries and corporate debt may have higher yields but an interesting fact in Japan is that there is healthy demand for high dividend yielding equity funds and Japanese corporations are aware of this and have responded so far. Dividend payouts are expected to further increase following strong earnings and will gradually close the gap between the payout ratios found in the U.S. and E.U.
Overcapacity is a valid concern and one that's taken very seriously in Japan. Nonetheless, I see autos leading the way for Japan as its big-3 continue to gain market share abroad with increased profits. In consumer electronics I see new and sustainable growth coming from cutting edge technologies such as the new DVD formats, 3G mobile telephony, SLR technology in digital cameras, and alternative power systems such as fuel-cell powered laptops and cell phones. Japan is also the global leader in solar cell production, a high growth sector.
On that note, and in closing remarks to your last point about where productivity will come from, I want to bring up the importance of Japan's ability to develop low-energy consuming products and its leadership in hybrid auto technology and solar cell technology. Despite Japan being completely dependent on oil imports, it holds advantages over competitors in energy saving technologies and processes. For human resources, an aging population will hurt Japan but I see it being largely offset by Japan's implementation of robotics (of which it has the largest capacity and is the largest producer of in the world) and hopefully in coming years its opening up to allowing more foreign workers in the country. Also, corporate restructuring and industry consolidation in addition to increased domestic and global competition will necessitate increased productivity if in fact Japan's economic recovery is for real this time. I believe it is. I look forward to any comments you have.
As you pointed out, Japan is a world leader in robotics. I have been thinking that one way that the US could deal with the movement of manufacturing jobs overseas would be to invest in roboticizing manufacturing processses. This would produce jobs maintaining the manufacturing systems, which jobs couldn't easily be shipped overseas.
There are two areas that I think Japan would do well to invest in that would provide economic growth and improve the country's standing in the world. First, I think that Japan should build a military force of a size that would allow Japan to take responsibility for its own security. As I am sure you are aware, there are many Japanese who would like to see the US remove its military facilities. I think that Japan should bear a greater portion of the financial burden of its own national security. Increased spending in this area would yield economic growth.
Second, I think that Japan should pursue an accelerated space program. This would provide technological spinoffs and raise Japan's profile in the world.
Finally, a book that anyone interested in Japan is Karel van Wolferen's book "The Enigma of Japanese Power." Although it was published a few years ago, it provides good insight into how Japanese government and businesses function.
Japan can't afford to build a big mililary because, 1) they don't have the people to do so, and 2) it is a politically sensitive move to do so. If you follow Japan's news, you know that Koizumi is trying to get changes made to the constitution to allow for a real military. Even if that is voted in, it will take generations for Japanese citizens to be comfortable with the idea of a military like Japan had previously. For over 50 years, Japan has been without a real military. Also, note the fact that Japan's Asian neighbors are not at all comfortable with Japan's moves towards a real military. That's another perspective that cannot be ignored. Japan's profile in Asia and it's history means that they cannot do anything without impacting others in this region. Finally, more Japanese in a professional military means less people to work. Japan may not be able to afford that.
As to your comments re: Japan's space program, I think that the govt. has been working to raise the profile of Japan's space program including the launches of satellites in the past few years, and then the recently reported high-altitude tests of prototypes in the Australian Outback. I agree it's an important growth area.
My reply to your guys' comments is that it is questionable if Japan can gain economically by becoming a "normal" country and building its own military forces. As it stands, Japan is essentially outsourcing (although within the same country) its military responsibilities to the U.S. per the Treaty of Mutual Cooperation and Security signed in 1960 (expanding on the Mutual Security Assistance Pact originally signed in 1952). By default then as an important U.S. ally, Japan also falls under the U.S. nuclear umbrella.
What many people don't know is that Japan is flipping the bill for all this protection. Just as it will with the recently reached Okinawa re-alignment decision, which will cost Japan an estimated 3-3.5 billion USD to relocate 7,000 U.S. marines. The argument then is if Japan didn't have to pay the U.S. for protection then it could build its own army. Well, Japan has what's called the <em>jieitai</... or SDF, which stands for the (Japan) Self-Defense Force. Also, per Japan's constitution approx. 1% of its GDP is allocated to the SDF and related “military
1. Corporate spending. Manufacturers are moving up the value chain. Steel and consumer electronics manufacturing has already moved overseas, but Japan still has an edge in the top-end stuff, for which they are investing in more production capacity. Koll points out that labor costs have fallen. They are also replacing the aging (and expensive) workforce with robots/automation.
2. Consumer spending will get a boost as many baby boomers retire and their children reaching 40 also increase leisure expenditures.
In my I have a link to an interview with Mizuho's chief economist who supports this view. In his opinion the recovery will last through 2013.
I agree that those are two areas that should have been addressed more. See my reply directly above to comments by scott146. It's lengthy but definitely addresses your first factor.
Neither Koll nor I really got into consumer spending but I think the stage is being set for increased spending going forward. I agree with you re. leisure expenditures will rise. At the same time as market sentiment improves and consumer confidence rises, the average consumer should begin spending more freely as the prolonged recession is officially pronounced over. Economic research and data show that over-saving and/or under-spending both have been found to be harmful to a national economy. In the U.S. it is dangerously under-saving and over-use of consumer debt financing that are problematic.
At the same time, many predict a US slowdown in 2006 or 2007; the housing market, which is a leading indicator, seems to be on the verge of a meltdown - this would severely impact households, and subsequently drag down the wider economy.
I would like to ask the group's opinions on how much impact a US slump would have on the Japanese economy, keeping in mind the fact that the Japan is less dependent on America than it used to be, and is now more linked with the Chinese and SE Asian markets. Would the effects of the US recession also pull Japan down, and by how much?
You're right, Koll is one among many economists and analysts (including myself) that recognize the current recovery in Japan; and this one being a sustainable one unlike previous false starts.
The U.S. real estate market is potentially the bubble equivalent of the tech run-up in the 90's and disaster post-March '00. Anticipating the threat of a real estate crash the Fed has been warning of "frothy" markets but the consensus seems to be there will be a "soft-landing."
That being said, in response to your question, I would say the impact on Japan of a U.S. economic slump will depend on the severity and timing of the slump. Japan is becoming less dependent on the U.S. but a high level of dependence still exists, and especially in areas such as autos.
I personally don't foresee a national real estate crisis -- which is said to be the catalyst that will most adversely impact the U.S. economy -- rather there are certain over-valued pockets such as Miami, Portland, and San Diego that will ultimately experience price corrections.
Therefore, I don't necessarily expect an imminent U.S. economic slump. Instead, I look at strong corporate earnings and solid Q3 economic performance in the wake of natural disasters. I think robust U.S. economic growth continues into '06 and possibly '07. After that, if the U.S. economy were to slow then we would have to evaluate how much Japan has recovered and its ability to grow against a weakening U.S. economy.