This is part one of a two-part blog series.
2013 has started out with a bang for the S&P 500, which has outpaced virtually all major developed world markets. Yet there is one major developed market that has kept pace: the Japanese Nikkei. As of April 9, the Nikkei has risen +11% in U.S. Dollar terms. Is the sun also rising in Japan, or are we seeing yet another false dawn?
Why does it matter?
Japan is the third largest economy in the world. It has been mired in decades of stagnation: tepid economic growth, deflation, aging population, and high fiscal debt and deficits. These challenges are compounded by a historically strong currency, which has pressured corporate profit margins, and a dysfunctional political system. As an example, Japan has had seven prime ministers in the last seven years. Yet in spite of its problems, Japan still retains some strengths, including world class companies and high wealth. Additionally, the Japanese banking system held up well in the midst of the 2008 crisis.
Japan is the banker to the rest of the world. If Japan suffers further problems, the rest of us eventually suffer. For example, Japan is the second largest foreign holder of U.S. Treasury bonds. Japanese companies continue to buy assets overseas. If Japan were to curb its interest in foreign diversification, that could have negative ripple effects not just in Japan but even in our market and elsewhere.
Finally, Japan poses a fascinating and relevant case study for the rest of the developed world. How does a mature economy with an aging demographic and indebted economy solve its problems? Or is it doomed to ultimate decay and/or default? Japan has more experience than the U.S. and Europe in dealing with these problems. For decades, Japan has experienced several decades of stagnation, a burst real estate bubble, and deflation. Expectations have risen that Japan is making serious efforts to begin resolving these issues with the election of Prime Minister Shinzo Abe. If progress is made, it could be a blueprint for how we in the U.S. might deal with our issues. If Japan fails, it could mean that our issues will be difficult to resolve without a major economic shock.
Look for Part Two of this blog next week!