This is another in a series of articles that makes a fundamental macroeconomic sectoral flow analysis of the economies of key countries across the globe.
The purpose of the review is to see if the local stock market is worth investing in via exchange traded funds (ETFs). These funds are available to all investors, even for non-residents or those not able to trade in the stock market of that country directly.
In this article, we examine Japan from a sectoral flow analysis perspective to see if the private sector, containing the local stock market, is getting the support it needs from the government and external sectors to continue its march upward.
Details of the methodology employed to analyze these opportunities are available in the sectoral analysis section found later in this article.
The magic formula for success is:
P = G + X
And you can read more about that below.
Which countries stock market are doing well and why?
The first port of call is the ETF page at Seeking Alpha and a look at country ETFs and how they are performing.
Since the start of this series of articles, last December 2016, Japan has been added to the list of country ETFs covered by SA. Japan is an important addition as it is so large an economic force. Japan jumps straight to fourteenth on the list and is up over nineteen percent over the last twelve months.
This article was to be about the Philippines, which is way down the SA list and in fact now negative for the last twelve months and no longer of interest for investors.
We will start the analysis with the government sector.
The Government of Japan provides the following summary of fiscal policy:
"Policies to achieve a society in which all citizens are dynamically engaged. Among others: ((i)) raise wages for childcare and long-term nursery workers; (ii) expand capacity of childcare facilities, so as to reduce the number of children on the waiting list; ((iii)) shorten the minimum eligible period for receiving pension from 25 to 10 years; (iv) lengthen the eligible period for maternity leave benefits; ((v)) reduce the employment insurance payments; and (vi) introduce a new government-sponsored scholarship. Economic revitalization. Focus on enhancing potential growth through combined efforts by private and public sectors; increase R&D expenditure; support innovation and new cutting-edge technologies (IoT, AI, robotics, etc.); and prioritize public investment in growth-enhancing areas. Working-style reform. Provide fiscal support for wage increase, introduction of regular intervals, and improvement of working condition of non-regular workers.
General expenditure. Meet the benchmark set out in the Fiscal Consolidation Plan in two consecutive years by duly controlling the growth of general expenditure (+ 530 billion yen). Sustainability of social security system. Control the growth of social security expenditures (+500 billion yen) in line with the Fiscal Consolidation Plan. Undertake various reforms for achieving fair burden sharing and appropriate benefit level. Among others: gradually lift the upper limit for high medical and nursery expenses for 70+ years old; (ii) review the temporary discount rate for 75+ years old on medical insurance premium; and introduce a new remuneration-based long-term nursery payment system. Bond issues. The planned bond issuance amount is on a downward trend (34.4 trillion yen)."
(Source: Government of Japan)
The following charts from the budgets shows where the money will be spent and the trend year over year.
(Source: Government of Japan)
The fiscal news is relatively good for the private sector with a planned and sustained government spending and expansionary policy. There is talk about fiscal consolidation (spending less), but this does not translate into spending less which is a good thing.
One can expect expansionary policy to take place and be sustained which is excellent for the private sector.
The chart below shows the government budget picture.
The Japanese government has been a net add to the private sector long-term. The government has at times also been a negative force as well and drained the private sector of funds. As a currency sovereign the Japanese government is the source of the funds and does not need to obtain them from the private sector by way of taxes or loans, it was done nonetheless. Rather like putting seawater back in the sea.
One sees the familiar pattern of declining deficits and then surplus budgets leading into recessionary periods. 1990, 200. There is then a return to deficit spending during the recession as the economic stabilizers deploy in the form of welfare payments and reduced tax "revenues" as people lose their jobs.
In 1990 Japan was the epicenter of a massive financial land led recession (the savings and loan crisis in America) and one can see how this was exacerbated by the surplus budgets of the time. Draining the private sector of liquidity when it needed it the most. One can see the extent of the impact of the 1990 financial crisis from the stock chart shown below.
Even after more than thirty years markets in Japan have not gone past the highs set in 1990. While assets prices have fallen, the debt was allowed to live on and is still serviced to this day. This debt millstone hangs around the neck of the economy causing fiscal drag "debt deflation" of aggregate demand.
At present, the deficit is a healthy six percent of GDP. However, GDP is falling which belies the belief that the inflow is stable as a chart further into this report will show.
The next chart shows the value of the budget and a measure of how much money is added or drained from the private sector by the government sector.
The chart shows that over the long term the government has been a positive help to the private sector. Every year for the last decade the government has injected more and more money into the private sector than it has taken out.
GDP is falling in Japan. This fact makes the actual contribution as a percentage by the government sector to the private sector appear more than the absolute contribution in money flows. In absolute terms, as the table and chart above show the amount is decreasing though the percentage is holding steady.
Japan has the following tax rates:
(Source: Trading Economics)
The rates of taxation are relatively high and skewed heavily for business with a 30.86% corporate tax while the wage earners are paying a 55.95% top marginal rate plus a 8% consumption tax on all they buy. On top of that is a 29.6% social security tax. All these taxes simply serve to dampen aggregate demand and comes back to the analogy that applies to a sovereign currency issuer in that one is returning seawater to the sea.
The Japanese consumer household has had a falling disposal income even since the 1990 financial crisis as the chart below shows. Disposable income is discretionary aggregate demand, and it has been flat for over twenty years and is gently falling.
The chart below, though a little old as this information is not easy to find for Japan, shows the level household debt to income. The chart is incidentally a good map of which land has the most expensive real estate in the world as most household debt is held as a house mortgage. The table also serves as a good guide to the lands that will be hardest hit in the next financial crisis.
The cost of accommodation has been flat for at least the last seven years as the chart below shows.
The Japanese government is the sovereign issuer of its currency unit; as the source of all money in the economy it does not need to obtain funding from the private sector via taxation or borrowing. This sort of economic thinking shows that the government is acting as if the gold standard still exists and that its spending needs to be squared off against a fixed quantity of gold; this has not been the case since 1971.
Japan has the western inspired self-imposed tradition of issuing a government bond to match deficit spending. This means that there is a "national debt" to point to. It also means that a large portion of private sector assets are held in the form of low-yield government bonds whereas they could have been invested in productive capital. This is a misallocation of resources.
This paints a picture of a government that is not aware of its currency creation powers, is obsessed with debt and driven by a now redundant gold standard budgeting mentality, and is unaware of its role as the provider of the medium of exchange.
The Japanese yield curve control experiment, covered later in this article, shows the government is developing an awareness of its sovereign currency creation powers. It may not take much longer for the government to make the connection between these powers, taxation and fiscal spending to further the public purpose.
Taxation that dampens aggregate demand and creates enormous and unnecessary tax collection dead-weight losses could be dropped and that resource more productively allocated.
Fiscal policy that is hemmed in by self-imposed constraints, such bond issuance, expanded by dropping those artificial constraints.
Expanding the money supply, debt free and not at interest, within the limits of set inflation, employment and currency exchange rates could begin. This is a far more intelligent basis than the current "old think."
Japan is an interesting study in bond market mechanics. Japan has shown that by using its currency creation powers it can control both ends of the yield curve. The short end is now set at negative rates and the long end it has pulled down by using its currency creation powers to buy all and any bond on issue to maintain its face value and lower the yield. On its current trajectory this is where the western bond market is headed following monetary instead of fiscal budgetary policy. Both the ECB and the FOMC have been doing this but not on such a grand and explicit scale.
All in all the government sector is adding about 150000 JPY HND Million per annum to the private sector.
The chart below shows the long-term balance of trade position.
The chart shows Japan had a strong balance of trade up to the 2007 GFC after that the thirty-year trend reversed and has more recently recovered.
The chart below shows the capital flow situation.
The chart indicates that the capital flows are a net positive since the late 1990's. After some weakness in 2013/14 former strength has returned
The chart below shows foreign direct investment.
The chart below shows the current account situation.
The current account pulls it all together and shows that when one considers the external sector's total impact, it is a big 2T JPY net add to the private sector each year.
The private sector can add to its income flows by borrowing. To gauge this one has to look at the rate of credit creation. Loans create deposits and generate reserves at the Central Bank.
The chat below shows loans to the private sector.
The chart shows that after a precipitous fall in 2000 down to 2005, the rate is rising again.
The consumer credit picture is the same as one can see from the chart below.
Private credit creation adds about 13000 JPY Billion per annum to the private sector.
Economic cycles are credit cycles that appear to run in twenty year patterns that terminate with a land led financial crisis. Termination comes when there are not enough creditworthy borrowers left who ready, willing and able to take on a loan. At this point aggregate demand collapses. The collapse is most keenly felt in the housing sector as this is where the most household debt is accumulated. The collapse is greater in those countries where house prices rose the most. In 1990 this was Germany, Switzerland and Japan. In 2007 it was America, England, NZ and Australia.
The savings and loans crisis of 1990, GFC of 2007 and GFC2 in 2027 appear pre-programmed. Ten years to go until the millennials are "all loaned up".
It takes twenty years to reach a point at which the present generation is "all loaned up." Usually, at this time, the government is running surplus budgets that are draining the private sector of funds at a time when the present generation is reaching maximum sustainable debt load. This further exacerbates the collapse in aggregate demand and deepens the recession. Asset prices fall with aggregate demand leaving only a shadow of debt behind.
The households in the private sector represent the consumers; the consumers are the reason the economy exists at all. Consumers are the cornerstone of aggregate demand. For best results the for the private sector and stock market, the consumer numbers need to be growing, have low debt and a high propensity to spend and consume. The Japanese consumer has none of these attributes.
The chart below shows there are fewer consumers in Japan each year.
Good that Japan is so good at competing on the world stage and can sell to consumers successfully in other countries as home demand is flat to falling.
With fewer people to go around one would expect relatively low unemployment and this is indeed the case as the two charts below show.
Policy statements in the government budget highlights, quoted earlier above, show the government is providing more child care facilities for working families to promote a higher birthrate and enable both parents to work while the baby is in daycare.
One can see the whole trend when one compares GDP with the amount of money in circulation, shown in the following two charts:
GDP has fallen since peaking in 2012\13. GDP is now at the same level as it was in the early 1990's over twenty years ago. The economy has dramatically shrunken over the last few years.
The money supply, on the other hand, has not fallen with GDP and this is inflationary as there is more currency and fewer transactions. The historical inflation rate is shown in the chart below.
The inflation rate did increase to nearly four percent in 2014 and has since fallen to less that one percent. One must remember that Japan now has total control over the yield curve through its rate setting and open market bond buying operations and this is why the rate of inflation is so low in the face of a rising money supply and falling GDP that would normally dictate otherwise. This is an exhibition of sovereign currency creation power and shows the government controls the bond market and not the bond holders.
Sectoral Analysis Methodology
Each nation state is composed of three essential components:
- The private sector
- The government sector
- The external sector
The private sector comprises the people, business, and community, and most importantly for investors, the stock market. For the stock market to move upward, this sector needs to be growing. This sector by itself is an engine for growth and innovation. However, it needs income from one or both of the other two sectors to grow in value. The private sector can also go into debt.
The government sector comprises the government with its judicial, legislative and regulatory power. The key for the stock market is that this sector can be both a source of funds to the private sector through spending and also a drain on funds through taxes.
The government through its Treasury also sets the prevailing interest rate and provides the medium of exchange. Too much is inflationary and too little is deflationary. It puts the oil in the economic engine and can put in as much as its target inflation rate allows. It is not financially constrained, for a sovereign government with a freely floating exchange rate any financial constraint such as a matching bond issue is a self-imposed constraint. A debt ceiling is also a self-imposed constraint as is a fiscal brake.
The external sector is trading with other countries. This sector can provide income from a positive trade balance, or it can drain funds from a negative trade balance.
One should note that a negative trade balance also means that a country has traded currency, that is in infinite supply, for real resources that have a finite supply.
For the stock market in the private sector to prosper and keep moving upward, income must enter the flow. Otherwise, the sector can only circulate existing funds or is being drained of funds and is in decline.
The ideal situation is that the private sector has a net inflow of funds and is always growing, thus giving the stock market headroom within which to expand in value. For this to happen, one or both of the other sectors have to be adding funds to the circular flow of income.
The following formula expresses this simple relationship.
Private Sector [P] = Government Sector [G]+ External Sector [X]
P = G + X
For the best investing outcome, one looks for countries where the government sector and external sector are both net adding to the private sector and causing the local stock market index to rise with the receipt of additional funds.
Japan is a buy. Our assessment criteria are met in that both the government sector and external sector are net adding funds to the private sector and this is finding expression in expanding house prices and the stock market.
When one looks at the sustainability of the income flows one can read that the government plans to continue its supportive expansionary policy for many years going forward. External flows show a large and steady trend onwards.
The private sector in Japan benefits from net inflows of:
150000 JPY HND Million per annum from the government sector.
13000 JPY Billion per annum from private credit creation.
2T JPY per annum from the external sector. Dwarfing the other two.
The government is demonstrating the power of sovereign currency creation by controlling both ends of the yield curve, and keeping it ultra low and flat, by setting a negative short-term rate and buying all and any long-term bonds on offer. A more sensible use of this power would have been fiscal programs to allow the private sector to deleverage from the 1990's credit binge, this would have added to productive capacity and built a better and more dynamic future.
Investors taking the positive investment view of Japan could try the following ETFs:
|EWJ||iShares MSCI Japan ETF|
|DXJ||WisdomTree Japan Hedged Equity Fund|
|DBJP||Deutsche X-trackers MSCI Japan Hedged Equity ETF|
|HEWJ||iShares Currency Hedged MSCI Japan ETF|
|DFJ||WisdomTree Japan SmallCap Dividend Fund|
|SCJ||iShares MSCI Japan Small-Cap ETF|
|DXJS||WisdomTree Japan Hedged SmallCap Equity Fund|
|JPXN||iShares JPX-Nikkei 400 ETF|
|FJP||First Trust Japan AlphaDEX Fund|
|DXJF||WisdomTree Japan Hedged Financials Fund|
|GSJY||Goldman Sachs ActiveBeta Japan Equity ETF|
|JPMV||iShares MSCI Japan Minimum Volatility ETF|
|DXJC||WisdomTree Japan Hedged Capital Goods Fund|
|HFXJ||IQ 50 Percent Hedged FTSE Japan ETF|
|JPN||Deutsche Trackers Japan JPX-Nikkei 400 Equity ETF|
|SCIJ||Scientific Beta Japan ETF|
|QJPN||SPDR MSCI Japan Quality Mix ETF|
|JHDG||WisdomTree Japan Hedged Quality Dividend Growth Fund|
|EZJ||Ultra MSCI Japan ETF|
|JPNL||The Direxion Daily Japan Bull 3X Shares ETF|
|DDJP||WisdomTree Dynamic Currency Hedged Japan Equity Fund|
|DEWJ||iShares Adaptive Currency Hedged MSCI Japan ETF|
|DXJH||WisdomTree Japan Hedged Health Care Fund|
|DXJR||WisdomTree Japan Hedged Real Estate Fund|
The next article will be a review of the more promising ETFs now that we have reached the end of the list of those countries whose stock market index is in positive territory over the last twelve months.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.