As much as moviegoers knew that Arnold Schwarzenegger in the movie Terminator “will be back”, investors knew inflation would eventually return to Japan. Yet unlike the hugely successful sequel which saw Terminator fans celebrating the return of their hero, investors in Japan have been anything but celebratory. Are investors proving to be too pessimistic, or is there reason for their pessimism?

We know that the case for a Japanese recovery hinges on one important variable: inflation. So at first glance, investors’ pessimism seems irrational, since the return of inflation will ultimately bring about a virtuous cycle – as goods and services produced by Japanese companies increase in price, underlying earnings increase; this leads to higher wages, which ultimately leads to more spending in the economy and so the virtuous cycle continues.