For many investors, the mere thought of Japan as being a role model is ridiculous. Yet, a study of the impact of Japanese demographics and policy on its financial markets would have provided valuable insights for European investors, says Ad van Tiggelen, Senior Investment Specialist at ING Investment Management. After all, Europe is the next region in line where the effects of an ageing population will be felt. What can we learn from the Japanese experience?
Almost a year ago I also wrote a column on this subject. At the time I noted that the fast ageing population and relatively restrained central bank policy of both Japan and the eurozone were likely to keep bond yields in these regions low for long. I also concluded that in both regions equities of globally diversified companies with a defensive business model would likely perform better than domestically focussed companies. In this sense, it is gratifying to see that the best performing sectors in European equity markets over the past 12 months were Healthcare and Food/ Beverage/Tobacco. The performance of only one year is hardly meaningful, but it fits a trend which could very well continue over the long term, as profit growth will become a scarce commodity in a developed world with low nominal GDP growth.
The historic developments in Japan support this view. Since 1993 an index with large non-financial Japanese companies, including all the main exporters has done significantly better than the broad Nikkei index or an index of domestically focussed small caps. Actually, investing in Japanese exporters would have yielded a positive absolute return in that twenty year period, even when the Nikkei index fell by 30%. It is quite simple when you think about it. It pays to invest in companies which export to the US and emerging markets, where the population is younger and, in certain cases, central banks are more willing to print money. A younger population still needs to invest in new houses, cars, etc, whilst an older one is less willing to spend and more inclined to save, fearful of an erosion of state pension schemes.
Of course, there are also big differences between Japan and the eurozone. One of those is the lack of homogeneity in the latter. This has recently been confirmed again by the contrasting fortunes of its member states. Where Germany continues to be an economic powerhouse, Cyprus is almost bankrupt. Where Spain and Greece show some hopeful early signs of regaining competitiveness, Italy sets itself back in time with its election result. Until now, the ECB has done a credible job positioning itself as a lender of last resort, acting as the glue which keeps the eurozone together. But will this ‘safety net’ approach be enough?
In this sense it is interesting to look at Japan again, where the central bank under new leadership now intends to battle deflation through a very liberal use of the printing press, a major break with the past. Unlike Japan, we still have inflation in the eurozone. This inflation is now mostly caused by tax increases of governments in austerity mode. This is probably a temporary phenomenon as one cannot increase the V.A.T every year. Recently, eurozone inflation has already fallen to 1.8%. A further fall is very likely. One has to wonder: will Japan also become a ‘role model’ in this respect? Will the ECB need to do more to stimulate the economy? We certainly would not be surprised if that would be the case.
