If you’re new to Asian stock markets, you might think that Japan’s stock market looks like a good place to invest. But you would be wrong. The world’s third-largest stock market is in an epic slump that will likely continue for another generation.
On the surface, Japan’s stock market looks promising. The Tokyo Stock Price Index, or TOPIX, trades at a price-to-earnings (P/E) ratio of 16, which isn’t terribly cheap – but is 20 percent below its 10-year average. Shares have fallen 20 percent from an 18-year high in June 2015, and are down an incredible 54 percent from their all-time high in December 1989. Japan is also the world’s third-largest economy, and is home to some of the world’s most famous brands, like Honda, Toyota, Sony and Uniqlo.
Long before China, Japan was the Asian economic miracle. Forty years after its defeat in World War II, Japan became the world’s second-largest economy. Companies all over the world studied its unique brand of innovation. By the 1980s, everyone wanted a Sony Walkman, a Nintendo video game console and a Honda Civic. “Made in Japan” meant quality and reliability. Japanese companies expanded aggressively and flooded the world with products.
But this growth was built on a shaky foundation. Japanese companies, lenders and governments cooperated to support growth in a way that couldn’t last. Banks were encouraged to keep lending at cheap rates to firms that had trouble paying them back in order to keep people employed.
This shaped a culture of protectionism, wastefulness and corporate collusion. Even now, only one-third of Tokyo-listed companies have any independent directors. (By comparison, in the U.S. half of the members of corporate boards of directors need to be from outside the company). This meant that no one was asking any questions about how companies were being run, or whether they were doing what was necessary to stay competitive.
Too much debt and a corporate culture that didn’t encourage innovation helped lead to the Japanese stock market bubble bursting in 1991. The economy slipped into a period of stagnation called the “Lost Decade” – that wound up lasting 20 years.
Over much of the past four years, though, investors have been more optimistic about Japan thanks to “Abenomics.” This refers to the economic policies introduced after the 2012 elections by Prime Minister Shinzo Abe. Abenomics focuses on reigniting the economy by getting Japanese citizens to spend more. The plan was to reduce interest rates and implement aggressive tax reform. Renewed investor optimism about Abe resulted in the stock market doubling by 2015.
Negative interest rates were introduced this year to help fight deflation, or falling prices. The Abe government was betting that negative interest rates – when banks essentially have to pay to keep money with the central bank – will motivate banks to lend more money. This in turn should support economic growth.
But Abenomics hasn’t worked yet. Low, and negative, interest rates haven’t prompted people to spend more. The yen has remained weak, hurting local companies’ overseas earnings. Japan also has a lot of debt – its debt-to-GDP ratio of 246 percent is the highest in the world.
Despite the government’s best efforts, Japan’s economy continues to shrink. More worryingly, many structural problems that were masked by the boom period haven’t been addressed.
One of the country’s biggest problems is its demographics. Recent government data showed that Japan’s population fell by 0.7 percent (or 1 million) between 2010 and 2015. The population is getting older and Japanese families aren’t having enough kids. So, Japan’s population crisis is just beginning.
According to a think-tank simulation, Japan’s population will decline by one-third by 2060. The ratio of those 65 or older will surge to nearly 40 percent by 2050 (compared to 20 percent in the U.S.), up from the current 24 percent (14 percent in the U.S.). This is a problem because people 65 or older generally don’t work and pay less in taxes. But they still collect government and corporate welfare and pensions.
With fewer working-age citizens to pay taxes (to fund what the government will be paying in old-age benefits), or to drive economic growth, Japan’s time bomb is exploding.
The government isn’t trying to fill the gap with immigrants, either. Less than 2 percent of the country’s population is non-Japanese, compared with about 13 percent in the U.S. and Germany. The United Nations estimates that unless Japanese citizens reproduce more, the country would need to attract about 650,000 immigrants a year to grow. But strong cultural resistance has stood in the way.
As a result of Japan’s stagnation, its position in the world economy is sliding. According to the Japan Center for Economic Research, the country’s gross national income accounted for 15 percent of the world’s total in 1995. It will fall to 5.2 percent in 2050 and 1.7 percent in 2100 if current trends continue.
Japan – like any other market – will occasionally offer short-term investment opportunities. Markets don’t move up, or down, in a straight line. But the long-term prospects for Japan – and its stock market – are dim.