Japan Confronts a Sea Change

July 12, 2023

Big changes are happening in Japan. Since the early 1990s, Japan has been fighting persistent deflation. Their inflation rate from 1995 to 2022 has been a low of negative 1.35% to a high of 2.76%. Consumer prices actually fell in 15 of those 28 years. Deflation discourages spending and investment. As a result, Japan has experienced an economic decline for the past three decades. However, now the opponent is inflation, which is driving up interest rates and stock returns in Japan. 

Demographics have changed everything. Workers have aged and are leaving the work force. This squeezes the supply of goods and services the economy can provide, while demand stays constant.

Here’s an example from Barron’s “Japan Confronts a Sea Change. What That Means for Investors” published Monday. "Japan is famous for its bluefin tuna used in sashimi and sushi-and for its huge fishing fleets. In the 1990s, the number of fishermen in Japan kept growing, while demand from buyers of fish remained stable. Fish prices fell.” Conversely, when the number of fishermen retire or die, the demand for tuna remains steady and prices go up rather than down. Lots of baby boomers across the world are dying or retiring.

In May 2023, the Japanese annual inflation rate was 3.2% and is expected to stay around there for some time. Japanese companies are thrilled. They can finally increase prices and make investments. Workers can get raises. Demand is higher. This leads to more economic growth which is a good thing. Businesses in Japan accustomed to holding large cash levels for tough times ahead are now issuing significant dividends and making buybacks. Dividends are up 51% since 2021 and buybacks have doubled. All of this is good for Japanese stocks.

As of last week, the Nikkei index had gained 27% for 2023 compared with 16% for the S&P 500 index. A well-diversified investment portfolio, such as those at DWM, have benefitted from this surge in Japanese stocks as well as other international and small cap stocks.

Of course, Japan is not the only country with aging populations. Most of Europe and the United States were beneficiaries of the baby boom generation for decades and now lots of their citizens are taking their nest eggs and going to the sidelines. This workforce decline in the population produces inflationary pressure.

As we have seen with Japan, moderate inflation can be quite helpful. Companies increase investments, wages go up and consumers keep buying. Deflation, on the other hand, is not a good thing.

Which leads us to the Federal Reserve’s next meeting on July 25-26. Yesterday, the Dept of Labor reported that inflation fell to 3% in June, the lowest in two years. There has been a slowdown in rent growth. Used-car prices are down. However, the Fed wants to get inflation down further, to 2%. They point to recent reports of tight labor market and wage increases of 4.7% annually. After raising interest rates 5% over 18 months, the Fed skipped raising rates in June. A .25% rate increase seems likely later this month.

It's no surprise that getting inflation down from 3% to 2% is going to be tough. Demographics in the U.S. are much different today than they were over the preceding 6 decades. Recently, from 2009-2021, inflation averaged less than 2% per year. But before then, from 1982-2008, inflation averaged about 3.5% per year. Many Americans remember paying mortgage interest rates of 6% to 15% per year from 1980-2008. Interest rates, of course, affect not only mortgages but also the stock market, particularly the large tech companies that have soared so far in 2023. We expect the rest of 2023 to be very interesting with lots of volatility. We recommend you (continue to) invest in a diversified, appropriate asset allocation and stay invested.

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