Posts tagged ‘Japan’
Since the summer of 2014 the economic landscape has changed in ways which ought to have brought joy to consumers in various parts of the world. The oil price has collapsed: good news for significant net importers like the USA. There, as in Britain too, job growth has brought the country to near-full employment. In the UK last year we saw positive, sustained growth in real wages for the first time since the Great Recession. In Europe and Japan, which have lagged those other economies in growth terms, central banks have tried to oil the wheels with rate cuts and the expansion of unconventional monetary measures.
Yet this week there were headlines in Britain about the weakness of consumer behaviour. It looked a running certainty earlier this year that the market panic was overdone. But are there signs showing here of strength for the bear case after all?
Looking at the UK first of all: no, not really. Consumer confidence reached 15-year highs last year, and while the survey measure has lost some steam into 2016 it remains above the running average over the year before that. Scrabbling around for negatives, the rate at which new car registrations increased fell to +6.5% in 2015 from +8.6% previously. This is hardly disastrous. And broad retail sales growth across all sectors averaged +4.5%, an 11-year high. The GDP print for Q4 2015 put the annual increase in household expenditure at +2.7%, up a little on 2014 and in line with long run averages. And while readers will know this blog is ambivalent on the subject of housing itself at present, mortgage approvals staged a recovery last year too after falling away in 2014 and that pickup has continued since year end.
The picture is a little cloudier across the Atlantic, but again, far from catastrophic. The personal consumption component of GDP for Q4 grew by +2.7% on the year – also in line with long term averages – though in this instance down from +3.2% in Q4 2014. Retail sales growth has fallen more obviously too, to a 12-month running average of +2.7% to March of this year down from +4.1% across calendar 2014. What is equally interesting, however, is that auto sales over the same period averaged 17.4m, up by a full 1m on 2014 and running at a 15-year high. Existing home sales, too, quickened in pace to the highest level since the credit crunch. Perhaps this is a sign that the net impact on consumption from oil has been disappointing, but that credit expansion has fueled asset purchases instead (a supposition reinforced by a rise in the level of student debt per capita). One can be ambivalent about this again, of course – but it is expansionary economic activity driven by consumer behaviour.
At the other end of the growth spectrum, Japan has had a terrible time of it in recent quarters. At the same time, recovery from yet another period of economic contraction has seen the downturn in household consumption as listed in the GDP figures abate, to a year-on-year pace of -1.3% for Q4 2015 as against -2.0% for Q4 2014. Car sales growth as well as broad retail sales growth has been flat; nationwide housing starts have risen measurably while condominium sales in Tokyo have declined again. So a more mixed picture here, but one which has not been declining any more than it has been showing signs of vibrancy overall.
Finally, Europe has also suffered something of a lost decade, having been through a double-dip recession which the US and UK were spared. Yet here the strength of the consumer has actually been most noticeable. The running 12-month average pace of retail sales growth is stronger now than it has been at any time since 2001. The household consumption component of eurozone GDP rose to an annual +1.7% in 2015 from 0.8% a year earlier, and sits well above the average of +1.1% seen since the zone began life in 2000. Data on building permits and mortgages outstanding show a marked rise over the last year, and passenger car registrations have been rising at a running average of +9.6% over the last twelve months up from +3.5% during 2014. It is most obvious to attribute stronger consumer demand here to cheap energy – as the eurozone is the biggest net oil importer by some distance, this is after all the most obvious place to look. (We should also note, however, that the unemployment rate has begun to fall at a faster pace in recent quarters too.)
For growth investors, growth rates have the constant potential to disappoint. These remain nervous, and volatile times. But if we take a good look at the available data there is nothing to suggest that developed-world consumption has done anything more than fail to respond to the theoretically benign tailwinds of cheap oil and monetary expansion in the way that some might have hoped. This is not the same thing as failing to respond at all.
So this week London entered a bear market. Some commentators discern echoes of the “2008 financial crash”. Sage market participants – who have been warning us about China* / Emerging Markets* / the Euro* / QE* / Commodities* / Debt* / Deflation* / Monetary Tightening* [*delete as appropriate] – for several years have finally been proved right. Several of them caution, sagely, that we should remain cautious as it could have further to go.
Yes, this week, the FTSE 100 Index entered a “bear market”, as defined by a fall in value from its closing peak (7,103.98 on 27 April 2015) of at least 20% – 20.14%, to be precise, reached on Wednesday with a closing price of 5,673.58. It should be obvious that this signifies nothing whatsoever more than a fall of 18% or 19% but there we are. Markets have their conventions. This is now, technically, a “crash” rather than a “correction” (a fall of between ten and twenty percent). And some would have us believe it’s 1929 all over again.
Such, however, it cannot be. Global equity (as measured by the MSCI World Index) has not entered a bear market – it has fallen by 17.62% from its peak – and this is entirely due to Wall Street. The S&P 500 has shed a mere 12.74% from its heady peak last May. Since the US market makes up a little under 60% of the developed world’s total market cap this more than makes up for the fact that Tokyo and … erm … Brussels? … have entered bear markets alongside London with the TOPIX and Euro Stoxx 50 indices down 23% and 25% respectively.
Even here in the UK the crash is not that clear cut. The mid cap FTSE 250 Index has shed only 14%, with the small cap index having done slightly better. Considering the fundamentals this is understandable. There are few oil supermajors bestriding this particular corner of the marketplace, or mineral colossi. The much vaunted overseas exposure of the large cap index has been, at best, an equivocal strength with the UK economy doing as well as it has (not to mention the distorting effects of all that foreign exchange exposure). So the current infestation of bears has been locally as well as globally selective.
Still, who needs “fundamentals” with all that lovely panic to go around! Surely it can only be a matter of time before those other columns tumble? After all, it’s 2008 all over again!
Except, of course – it isn’t. Not even remotely so. Back in 2007, to refresh our memories, there was a massive over-extension of credit via packaged structures that were as poorly valued and understood as they were widely held. A few mortgage arrears in the US later and the world’s financial system suffered cumulative capital losses just shy of $2trn and would have collapsed without the $1.5trn of capital that then had to be pumped into it, mostly by governments. Then in the autumn of 2011 it looked as though the bond market might close to Italy. Since the Italian economy is rather large, with a commensurate burden of sovereign debt, it was certain that neither the IMF nor its sponsoring governments would have been able to afford a bailout. At that point we could have seen governments across the developed world plunged into default.
Now that would have been a disaster.
And what is behind the doomsaying today? The rate of GDP growth in China down by 0.1%! Oil falling – which is admittedly more dramatic – but unlike the financial crisis will prove an economic benefit on average (and perhaps delay the need for monetary tightening in Britain and elsewhere). Or perhaps it is simply the case that the bull market run since 2009 got ahead of itself and equities are anticipating the forthcoming change of cycle.
On that last point there is something further to be said about all those crashes and corrections. Amid the justifiable fear of 2011 the S&P 500 had a peak-to-trough fall of 19.4%. Admittedly, this is a whole 0.6% short of a full-blown bear market, or “official” crash. But it was not much fun for investors at the time. And away from the US, stock markets have had a much more equivocal rally. While the S&P raced ahead during 2013 and 2014 for instance, returning 50% over those two years, the FTSE 100 returned only 20%. In Japan, suffering from the earthquake and tsunami of 2011 and their aftermath, the market did not even start to climb until the tail end of 2012. The years since the credit crunch and Great Recession have seen healthy equity market returns – at times, in some places, and in fits and starts. But it has not been any sort of eye-watering, valuation-busting rocket trip.
We are where we are. But the crash has been as partial as the bull run, the panic is hard to justify – in some respects, even, absurd – and it may yet prove that all the doomsaying is being listened to just a little too closely.
Much like last year, 2015 has got off to an exciting start. This blog identified interest rates as an important market theme, and though the Fed (and to a lesser extent the Bank of England) have been positioning expectations for a tightening of policy at some point it has been the new emergency monetary measures in Europe which have dominated attention thus far. Mr Draghi can take much of the credit for turning around sentiment on the sovereign debt malady in 2012, attracted further limelight last year by introducing negative deposit rates among other things and yesterday, of course, officially announced the start of quantitative easing in the eurozone. As with his other announcements this one has been taken well: the Stoxx 50 has risen by more than 10% over the last couple of weeks, bonds in Greece and elsewhere in the eurozone periphery have found some support and he will not mind that the euro, which has fallen by 3% against the dollar in the last two days alone, now stands at levels last reached in the summer of 2003.
Fears over the prospects for Europe are nowhere near as powerful as they were in the days of the Bond Market Terror when Draghi took the helm in November 2011. Today the fear is that the Continent will follow the “deflationary spiral” which sucked the Japanese economy under the waves for so many years, as people defer spending decisions, companies delay production, activity thus contracts (exacerbating the price effect) and the bells of doom generally begin to toll.
Or so the story goes. The Japanese experience was / is not actually like that. After the collapse of the 1980s economic and investment boom the stock market crashed in 1990, growth began to slow, and the Bank of Japan cut rates accordingly. The yen, however, was allowed to appreciate by over 50% on a trade weighted basis at the same time, more than compensating for this effect and ensuring a recession which saw growth move sideways for two years. Annual inflation, on the other hand, didn’t turn negative until 1994 – and in 1995-6 the economy motored along just fine. The first bout of Japanese deflation was therefore a symptom of the malaise, not its cause.
Then came the 1997 collapse of the Asian tiger economies, the Japanese banking crisis and another unwelcome period of massive yen appreciation. It was at this point that the zero-interest rate policy, “ZIRP”, came along. Then of course there followed the collapse of the TMT boom. So the level of Japanese real GDP moved sideways for five years this time (1997-2002). Although deflation did not begin in earnest until the 2000s, its association with Japan’s “lost decade” had become intractable, and the idea of deflation as a cause of her problems, rather than a symptom of them, an established part of the market narrative.
Looking at this another way, Japan is not the only economy to have experienced deflation in the recent past. Did you know that Switzerland, for example, saw a pronounced deflationary period from 2011 to 2013? Or that Singapore officially entered deflation a month before the eurozone? Nor is it only countries beginning with “S”: Israel has been deflating quite cheerfully since the autumn, joined last month by neighbouring Lebanon. None of these places are forecast to suffer Armageddon as a result.
One could also mention that “core” inflation in Europe remains positive … but by this stage the point ought to be well made.
Of course, a lot of market narratives can become self-fulfilling. For this, if for no other reason, it should come as a relief to see the latest round of “open mouth operations” at the ECB enjoying a positive reception.
As a last word on this subject – for now! – it also salutary to observe what happened to Japanese asset pricing during the first decade of this century. Ten year bond yields did not tend to trade at 0.4%, for example, even with deflation all around, QE in train and the policy rate at or near zero. Nor did equities experience a terminal spiral of death, or the yen perpetually depreciate. But all of that is a much longer story.
Towards the end of last year this blog noted that growth would be a key theme for 2014: “A gathering of momentum … should see gloom continue to recede from markets which have had to trudge through a bruising and tedious few years.”
And then we had news out yesterday that the US economy shrank a little in Q1, contrary to the advance estimate that it was ever so slightly up. Two weeks previously, the eurozone economy was reported to have grown by 0.2% in the same period – half the forecast rate.
So is growth falling away again? And if so, will we see gloom return?
The answer to the second question, so far, is a clear “no”. The last time we had a negative quarter for US GDP was Q1 2011. When reported in the summer of that year it triggered an almighty panic; this week’s news hardly caused a ripple. Of course the market backdrop is different now, with the sovereign debt crisis not as raw and the credit crunch more distant a memory. But the evidence on the first question suggests that markets are behaving rationally rather than over-exuberantly in taking Q1 data in their stride.
Weakness in the US was widely expected in the first quarter. We know that the very harsh winter had a role to play and there seems to have been some contraction due to inventory building in 2013. Both these may fall away – and other data strongly suggests that they will do so, with durable goods orders, retail sales, manufacturing output and consumer confidence all rebounding from winter lows, real estate activity stabilising with mortgage rates and unemployment measures declining convincingly.
The European picture is a little more equivocal, with much of the shock being due to unexpected stagnation in France (a risk I highlighted back in January). And we wait to see just how negative the effect of last month’s sales tax hike will have been in Japan. At the same time, however, GDP growth here in the UK has held its ground admirably, activity indicators suggest it will continue to do so and only this morning, the consumer confidence index from GfK reached its highest level for over nine years. In Europe too, the broad economic sentiment indicator for the eurozone as a whole has kept on climbing even as French business sentiment has weakened a little.
It is always disappointing to see economies shrink of course, and a blemish on recent quarters for the developed world. Up until the US data revision this week the American, eurozone, Japanese and UK economies had all been growing for four consecutive quarters, the longest unbroken stretch since the early days of recovery from the Great Recession in mid-2009 to 2010. But looking at the bigger picture it seems very unlikely that we are about to experience another round of sclerosis a la 2012.
Altogether, then, the growth picture is consistent with the conclusion drawn last week regarding corporate activity: that we are witnessing an unwelcome hiatus rather than a more serious trend reversal. Again, this is not an especially exciting position for the world to be in; but given the form which excitement has tended to take in recent years, we should not perhaps feel overly glum about this.
Winston Churchill famously observed of Russia in 1939 that it was “a riddle, wrapped in a mystery, inside an enigma”. To outside investors, much the same can be said of Japan. Can Abenomics, which in policy terms amounts to the same again (but this time with feeling), really change the dreary landscape of Japan’s lost decades for the better? Is this a question we can even answer yet?
Last week’s GDP data certainly confirmed the Japanese recovery. And just as interestingly, consensus forecast data compiled by Bloomberg a few days earlier showed that inflation expectations for next year ticked up to 2.4%. That would be the highest rate since 1997. Together with a consensus forecast of 1.6% for 2015 this would represent the strongest rate of sustained price growth since the opening years of the 1990s – finally, a real end to deflation.
There is the matter of an increase in sales taxes to account for, of course. Coming in next April this is expected to have a material impact on GDP over the first two quarters and on prices over the year as a whole. (The consumption tax is being increased as a nod to containing the national debt.) Even so, the change in sentiment since former Prime Minister Yoshihiko Noda dissolved parliament – almost exactly a year ago now – is significant.
There is arguably something of a contrast between expectations for prices and growth, however. While inflation is expected to return to a much happier level, GDP is only forecast to put on 1.6% next year and 1.2% in 2015. This is below the average for the five years leading up to the Great Recession, and well below the 4% level of growth seen in the boom years of the 1980s (when inflation averaged a not especially troubling 2.6%).
This is difficult to weave together into sense. On the one hand, Abenomics is expected to put an end to decades of deflation. On the other, the growth impact is expected to be disappointing. Given the history of the last 30 years it actually seems very bearish to expect Japanese inflation to take off without growth picking up at the same time. And yet with the stock market up 68% over the last 12 months investor sentiment in Tokyo has been anything but.
We should not read too much into this since economic forecasts are works of fiction. It is possible that Abenomics disappoints, as some expect, and what Japan actually gets is disappointing growth, a significant fall back in prices after the effect of the sales tax wears off and a return to conversations about the stratospheric level of gross government debt and the demographic death spiral. It is equally possible that Abenomics succeeds and that the Japanese economy motors back into life. After all, the country’s share of global GDP increased from 10.6% in 1979 to 18.1% in 1994, according to World Bank figures. Since then it has slipped back down to 8.3%: a shade lower than where it stood all the way back in 1972.
If the economic outlook is enigmatic though the prospect for Japanese asset prices is even more so. Inflation expectations have risen considerably, yet the ten-year government bond yields 0.6% – a little below where it stood a year ago, well under the 1.1% averaged since the beginning of the Great Recession and a million miles away from the 5.5% averaged over the late 1980s and early 1990s. There is the faster pace of central bank buying to take into account, at least for the moment; but with deflation killed off this should surely be expected to unwind. Unless deflation is not killed off after all …
On the equity side of things the picture is even less certain. Japanese equity market valuations are a law unto themselves. Bloomberg puts the p/e for the Nikkei 225 at 22x. While this beats every other major market, it is actually rather low for Tokyo. Even when bond yields and inflation were at more “normal” levels a quarter of a century ago, the market was still comfortable with multiples of 60x and higher for several years. A lot of this reflected hysterical optimism of course, but still. An earnings yield of 4.5% compares favourably with a risk free rate of 0.6% and inflation of 1.5-2%. Yet the fact that the earnings yield was quite often under 1% while bonds were at 5% suggests that the Japanese market pays these valuation niceties very little attention whatsoever. And who is to say a p/e of 60x will not become the new normal again, whatever happens to interest rates and inflation – if Abenomics should work, after all …
It is not really possible to write off the world’s third-largest economy as an investment destination. But if we think we should understand what we are investing in, Japan presents us with a particularly steep challenge. Despite the stock market optimism of the recent past, this has if anything got worse: everyone seems to be expecting Abenomics to have a bracing effect, but there is little clarity on how this will translate into outcomes. And there is no clarity at all on how the major asset classes should behave no matter what the eventual outcome is.
Stock pickers will find some names of interest and bond investors have little to lose by staying away. But it is very difficult indeed to put together a medium term case for either loving or loathing Japanese assets – and that, in itself, should augur caution.
On the 23rd of May the Nikkei 225 Stock Average in Tokyo closed 7.3% lower, the biggest daily fall since the Great East Japan Earthquake of 2011. By yesterday the index was down almost 20% from its peak just over a fortnight previously.
At the beginning of this episode there was a lot of speculative attribution of cause. Was weak manufacturing data from China responsible? Or perhaps the Federal Reserve would end its stimulus programme as the US recovery strengthened? Whatever the reason, it was not clear whether the fall would represent a correction for a market which had enjoyed a dizzying bull run, or a kamikaze attack on equity pricing globally.
A couple of weeks later it is tentatively possible to point to the former. The Euro Stoxx 50 and the FTSE 100 are down about 4% and 6% since the 22nd. The S&P 500 has drifted all of 1% lower. And rather closer to Tokyo, the Shanghai Composite has fallen by less than 4%.
Furthermore, if the sharp downward pressure on the Nikkei lately does turn out to be specific to Japan it will reflect market pressures, not fundamental changes to the behaviour of or outlook for the economy. Much the same could be said of the way up of course and the index remains 24% higher for the year to date. But on the very day the tumble began, the Bank of Japan published its Monthly Report for May saying that growth was generally picking up. Since then, there have been positive surprises from a range of indicators including retail sales, industrial production and housing activity.
Moving back west the data has also been surprising. There was a nasty shock from the US on Monday when the ISM index of manufacturing activity indicated a mild contraction, falling to its lowest level since mid-2009. But in Europe the news has been good. In the UK we have seen stronger-than-expected activity levels across the economy – in manufacturing, services and construction – together with a continued gentle increase in house prices and firming of confidence (a connection which will be familiar to readers). In the benighted old eurozone itself PMI data has begun to recover a little more quickly than anticipated as well, and confidence indicators have also been strengthening. Only yesterday, ECB President Draghi told a press conference that the zone would return to growth this year (though the bank is keeping further emergency measures up its sleeve in case the crisis should deepen again).
It is interesting that European stock markets fell in response to Draghi’s remarks. The logic of course was that more emergency stimulus would have been better – though another perspective would be relief at the assessed absence of the requisite emergency. (Markets often respond in disobliging ways to central bank activity.)
It is still too early to write off the risk of contagion from Japan, especially if the correction becomes a full-on collapse. It would be hugely premature to write off the possibility of another emergency for the ECB to contend with. But it is worth observing that we are almost half way through 2013 and about a year from the point at which market confidence really began to recover from the 2011 crash. Japan’s rally has been an impressive spectacle. The avoidance of catastrophe and an end to the recession in Europe could be a major game changer.
We are only 46 days into 2013, but it feels as though markets have covered a lot of ground already. The FTSE 100 index is up 7.5% so far, which would make a decent positive return for a full year. So it is something of a relief that risk assets have had their exuberance contained in the last week or two by weaker than expected Q4 growth numbers from the major developed economies (the US at the end of last month, Japan on Wednesday and the eurozone a day ago).
With all the excitement we have been enjoying in equity markets, however, it has been easy to overlook the more mundane – and in some cases, divergent – pricing behaviour of other assets.
Oil, for example, is only $4-$5 a barrel higher, and remains well below the levels reached in early 2012. The story is similar for industrial metals.
Precious metals have been more enigmatic. Silver had a strong January but has since fallen to where it ended last year. Gold shrugged off the euphoria last month to begin the year flat, before dropping just shy of 3% in dollar terms in what we have seen of February so far. Both metals remain on the downward trajectories established for them since risk assets began to recover a few months ago, but the shorter term dislocations and contradictions are as mystifying as ever.
More mystifying still has been the behaviour of credit. Safe haven government bond markets have been acting as one might expect: 10 year yields in the US, Germany and the UK are 25-35bp higher on the year so far. But investment grade credit spreads, as measured by the Markit iTraxx Europe index, are barely narrower from December’s close. At the same time, the rally in emerging market debt has stalled, with the JP Morgan EMBI Global spread a few bp wider.
Currency markets, more reassuringly, are aping equities in that they have also paused for breath this month after following a consistent pattern. The euro rallied strongly, and has now faltered. The yen continued its sharp decline – which has slowed. The world’s new-found and startling allergy to sterling has stabilised. All this could tie rationally in with improving sentiment over the world economy (now paused) and the abandonment of safe havens (ditto).
The economic outlook, as always, is uncertain. Those GDP numbers we’ve seen of late have not been encouraging. But other data has been positive: on American jobs, Chinese activity, European (and UK) sentiment … So far, despite the hiatus, and the short term dislocation in risk pricing between some asset classes, markets are giving the world the benefit of the doubt.
This blog is inclined to agree with them. There is one market we have been following for some time: the peripheral European bond market. Back in November ’11, when panic was the only thing some wanted to buy and Italian 10 year paper was hovering around 7-7.5%, we observed:
It was hugely significant during the recent [Aug 11] crash that Italy’s bond yields did not rise to dangerous levels. If they continue to hold their ground – or better yet, if confidence improves and they fall – catastrophic contagion in the eurozone is unlikely to occur. Talk about the banks, and haircuts, and credit derivatives is all very interesting. But if you really want to know how afraid to feel, just keep an eye on those bonds.
Year to date, spreads on Spanish, Italian, Greek and Portuguese debt to Germany have continued to narrow. This measure has survived the stall in equity pricing. In terms of absolute yield, Portuguese 10-year debt has fallen from almost 14% to a little over 6% in under a year.
Bond markets have decided that fear is not going to win this winter. As ever, their view is subject to the verdict of time. And as ever, the inconsistencies and dislocations we have seen emerging during the excitement of 2013 so far will be resolved – one way or another.