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Japan in Recession
As we have opined in previous newsletters, the Japaneseeconomy is closely linked to the fortunes of the USA. Notonly are the Japanese sitting on a pile of almost US$1trnin US treasuries and equities, and thus exposed to aweakening US dollar, most of the countries that are Japan'salternative customers are buying manufacturing equipment,tools, and parts for products that are ultimately sold inthe USA. In our experience, this means that you can look atthe coming US recession and add 3 months prior and 6-9months post to figure out the duration of impact on Japan.Goldman Sachs reckons the US is already tipping intorecession and will be there for at least a quarter, so weexpect the impact on Japan to last until Q3 or Q4.
2. Japanese Stocks Stay Down
Not only the troubles in the US, the fact that China is inan end-run into the Olympics will mean that a lot ofattention will be paid to the middle kingdom at the expenseof Japan. Stock market returns there were stellar lastyear, and will probably be strong again this year, at leastuntil Q4. Without large foreign investment coming into theJapan stock market, and with the local individual investorsstill running for cover, we see the Nikkei dropping furtherfor at least the first half of 2008. The second half,however, should be a come back story, so long as the US Fedmanages its way out of the Stagflation trap it seems to befalling in to (i.e., rising prices but little growth).
3. Increase in Bankruptcies
In Q1, wealth-intensive sectors such as real estate,stocks, autos, etc., will continue to weaken. Althoughthere is plenty of cash under the mattresses of localinvestors, the widening gap in incomes between the havesand have nots means that there is a thinning of the rankson the consumer side of those investments. This macroenvironment coupled with tightening regulations on loansand credit to smaller companies, will remove a lot of thebusiness flow that small and medium-sized businesseshave had in the past. As a result, we think the level ofbankruptcies of SMEs will peak mid-year, and we wouldn't besurprised to see the government have to unwind itslegislation that requires the Hosho Kyokai (GuaranteeCorporations) to spread 20% of their risk on SME loans, tothe banks. Given that the banks are so conservative inJapan, this was a ridiculous rule to impose in the firstplace.
4. Backing the Post Office
With the government back-tracking on reform, and thuscreating a likely blow-out of the budget, one of thebiggest sources of emergency funds in the past has beenPost Office savings. The only trouble is that thegovernment under Junichiro Koizumi removed the incentives(extra interest rates and anonymous accounts) for peopleto keep their money with the Post Office. We wouldn't besurprised if a program to restore funds to the Post Officewas developed, giving the Post Office an unfair advantageonce more, over the banks. The easiest way to do thiswould be to create a tax-advantaged savings bond forindividuals to invest in. This would suck billions out ofthe market and give the government the capital they needto service their pork-barrel projects and the deterioratingpension program.
5. Japanese M&A of Foreign Firms Increases
Although there is tremendous pressure on the SMEs, forthose companies large and profitable enough, there is stilla bottomless well of cheap funds available locally. Theemergence of yet another previously government-owned bank,this time the Development Bank of Japan, will mean thatsignificant fresh risk capital will be available forcredit-worthy customers to go do M&As. But as the recentboom has proven, export markets are where the cash is, sowe expect that the M&As will follow a similar overseas path-- ideal for the DBJ, which is an old hand at internationaltransactions. Expect particular M&A action in Asia andNorth America. Further, expect Japanese trading companiesto continue their consolidation of control of the miningand transport of raw materials, particularly in the energyand rare earth mining sectors.
6. Yen goes to JPY100 to the Dollar
While the Japanese government is deep in debt, and thepopulation is getting older, these negatives are a slowmalaise and will not significantly threaten Japan foranother 10-20 years. Thus, Japan offers a safe haven forfunds in the short term. The energy producers of the worldin particular like Japan and have a good impression of itssustainability and continuing ability to produce newtechnologies and products. Thus, inbound investments suchas the Dubai International Capital fund's JPY50bn into Sonyis probably a precursor of major investments by othersovereign funds -- particularly from the Middle East,China, and Russia.
7. Fukuda Calls Snap Election Late in the Year
The DPJ opposition party has been making the most of theircontrol of the Upper House in the Japanese parliament, andhave been playing the ruling party LDP particularly well.However, the fall-out late last year between DPJ bossIchiro Ozawa and some of the party's other leaders showsthat all is not well in the DPJ. 2008 will be marked bynumerous clashes between the two parties -- a historicperiod of open conflict for Japanese politics, and wethink the strain of it all will take its toll bothemotionally and physically on the DPJ leadership -- Ozawain particular. If bad health puts him in hospital, or ifratcheting up the pressure causes the DPJ to come across tothe public as a bully-boy spoiler, then expect Fukuda toseize the opportunity to call a snap election.
8. Birth Rate Drops Further
Despite a slight improvement in the birthrate in 2007, thedepressing news coverage of the economic outlook for 2008will probably cause many couples who can actually have ababy to put off plans for an extra mouth to feed. For thosewho can't have kids, the causes and treatment ofinfertility will start to rise in the media, and the trueextent of medical problems in the female population willbecome better known. The government will enact newlegislation so as to be seen to be doing something, butunfortunately, the permissive lifestyle, changing dietpatterns, and other environmental factors will be too deepseated for any reasonable effect to be seen. Increasedforeign intermarriage and early childhood education abouthealth are two factors that will need to be addressed inthe future. But it's hard to see these happening in 2008.
9. Electric Car Hype Increases
Oil priced over US$50 a barrel makes electric and hybridcars economically feasible. US$100 a barrel make themimperative. The big hurdle to auto makers producing aviable electric car today is the lack of reliable lithium-ionor other high-density batteries with which to power suchvehicles. The Japanese have pretty much tied up the world'sproduction of rechargeable batteries, and so it is onlynatural to assume that the materials scientists here areall beavering away to find the right mix of basic tech andmanufacturing to create a breakthrough product. They can'tbe far away, because companies like Mitsubishi don't makemulti-hundred million dollar battery factory investmentson a wing and a prayer. A number of interestingtechnologies are hitting the news in the USA, such thenano-processing aspects of Altair Nano. News announcementsare still quiet in Japan, but already Toyota has said thatit has similar technology to Altair and that it doesn'texpect to be trumped in the battery stakes. The first twoproducts to the market are supposed to be the MitsubishiMiEV and the Subaru R1e mid- to late-next year, andToyota in 2010 or 2011.http://www.greencarcongress.com/2007/12/electric-subaru.html.
10. More Cancer and Genetics Breakthroughs
One aspect of the Japanese is a safe bet -- they're greatincrementalists. And thus, any area of academic study wheresheer horsepower and tenacity are required, the Japanesehave an excellent chance of creating a breakthrough.Traditionally in industry this has meant materials science,but now body chemistry can be added to the prize ring. We expect a number of significant announcements in the areasof genetics, cancer diagnosis, stem cells, and similaravenues of biotech research.
As we have opined in previous newsletters, the Japaneseeconomy is closely linked to the fortunes of the USA. Notonly are the Japanese sitting on a pile of almost US$1trnin US treasuries and equities, and thus exposed to aweakening US dollar, most of the countries that are Japan'salternative customers are buying manufacturing equipment,tools, and parts for products that are ultimately sold inthe USA. In our experience, this means that you can look atthe coming US recession and add 3 months prior and 6-9months post to figure out the duration of impact on Japan.Goldman Sachs reckons the US is already tipping intorecession and will be there for at least a quarter, so weexpect the impact on Japan to last until Q3 or Q4.
2. Japanese Stocks Stay Down
Not only the troubles in the US, the fact that China is inan end-run into the Olympics will mean that a lot ofattention will be paid to the middle kingdom at the expenseof Japan. Stock market returns there were stellar lastyear, and will probably be strong again this year, at leastuntil Q4. Without large foreign investment coming into theJapan stock market, and with the local individual investorsstill running for cover, we see the Nikkei dropping furtherfor at least the first half of 2008. The second half,however, should be a come back story, so long as the US Fedmanages its way out of the Stagflation trap it seems to befalling in to (i.e., rising prices but little growth).
3. Increase in Bankruptcies
In Q1, wealth-intensive sectors such as real estate,stocks, autos, etc., will continue to weaken. Althoughthere is plenty of cash under the mattresses of localinvestors, the widening gap in incomes between the havesand have nots means that there is a thinning of the rankson the consumer side of those investments. This macroenvironment coupled with tightening regulations on loansand credit to smaller companies, will remove a lot of thebusiness flow that small and medium-sized businesseshave had in the past. As a result, we think the level ofbankruptcies of SMEs will peak mid-year, and we wouldn't besurprised to see the government have to unwind itslegislation that requires the Hosho Kyokai (GuaranteeCorporations) to spread 20% of their risk on SME loans, tothe banks. Given that the banks are so conservative inJapan, this was a ridiculous rule to impose in the firstplace.
4. Backing the Post Office
With the government back-tracking on reform, and thuscreating a likely blow-out of the budget, one of thebiggest sources of emergency funds in the past has beenPost Office savings. The only trouble is that thegovernment under Junichiro Koizumi removed the incentives(extra interest rates and anonymous accounts) for peopleto keep their money with the Post Office. We wouldn't besurprised if a program to restore funds to the Post Officewas developed, giving the Post Office an unfair advantageonce more, over the banks. The easiest way to do thiswould be to create a tax-advantaged savings bond forindividuals to invest in. This would suck billions out ofthe market and give the government the capital they needto service their pork-barrel projects and the deterioratingpension program.
5. Japanese M&A of Foreign Firms Increases
Although there is tremendous pressure on the SMEs, forthose companies large and profitable enough, there is stilla bottomless well of cheap funds available locally. Theemergence of yet another previously government-owned bank,this time the Development Bank of Japan, will mean thatsignificant fresh risk capital will be available forcredit-worthy customers to go do M&As. But as the recentboom has proven, export markets are where the cash is, sowe expect that the M&As will follow a similar overseas path-- ideal for the DBJ, which is an old hand at internationaltransactions. Expect particular M&A action in Asia andNorth America. Further, expect Japanese trading companiesto continue their consolidation of control of the miningand transport of raw materials, particularly in the energyand rare earth mining sectors.
6. Yen goes to JPY100 to the Dollar
While the Japanese government is deep in debt, and thepopulation is getting older, these negatives are a slowmalaise and will not significantly threaten Japan foranother 10-20 years. Thus, Japan offers a safe haven forfunds in the short term. The energy producers of the worldin particular like Japan and have a good impression of itssustainability and continuing ability to produce newtechnologies and products. Thus, inbound investments suchas the Dubai International Capital fund's JPY50bn into Sonyis probably a precursor of major investments by othersovereign funds -- particularly from the Middle East,China, and Russia.
7. Fukuda Calls Snap Election Late in the Year
The DPJ opposition party has been making the most of theircontrol of the Upper House in the Japanese parliament, andhave been playing the ruling party LDP particularly well.However, the fall-out late last year between DPJ bossIchiro Ozawa and some of the party's other leaders showsthat all is not well in the DPJ. 2008 will be marked bynumerous clashes between the two parties -- a historicperiod of open conflict for Japanese politics, and wethink the strain of it all will take its toll bothemotionally and physically on the DPJ leadership -- Ozawain particular. If bad health puts him in hospital, or ifratcheting up the pressure causes the DPJ to come across tothe public as a bully-boy spoiler, then expect Fukuda toseize the opportunity to call a snap election.
8. Birth Rate Drops Further
Despite a slight improvement in the birthrate in 2007, thedepressing news coverage of the economic outlook for 2008will probably cause many couples who can actually have ababy to put off plans for an extra mouth to feed. For thosewho can't have kids, the causes and treatment ofinfertility will start to rise in the media, and the trueextent of medical problems in the female population willbecome better known. The government will enact newlegislation so as to be seen to be doing something, butunfortunately, the permissive lifestyle, changing dietpatterns, and other environmental factors will be too deepseated for any reasonable effect to be seen. Increasedforeign intermarriage and early childhood education abouthealth are two factors that will need to be addressed inthe future. But it's hard to see these happening in 2008.
9. Electric Car Hype Increases
Oil priced over US$50 a barrel makes electric and hybridcars economically feasible. US$100 a barrel make themimperative. The big hurdle to auto makers producing aviable electric car today is the lack of reliable lithium-ionor other high-density batteries with which to power suchvehicles. The Japanese have pretty much tied up the world'sproduction of rechargeable batteries, and so it is onlynatural to assume that the materials scientists here areall beavering away to find the right mix of basic tech andmanufacturing to create a breakthrough product. They can'tbe far away, because companies like Mitsubishi don't makemulti-hundred million dollar battery factory investmentson a wing and a prayer. A number of interestingtechnologies are hitting the news in the USA, such thenano-processing aspects of Altair Nano. News announcementsare still quiet in Japan, but already Toyota has said thatit has similar technology to Altair and that it doesn'texpect to be trumped in the battery stakes. The first twoproducts to the market are supposed to be the MitsubishiMiEV and the Subaru R1e mid- to late-next year, andToyota in 2010 or 2011.http://www.greencarcongress.com/2007/12/electric-subaru.html.
10. More Cancer and Genetics Breakthroughs
One aspect of the Japanese is a safe bet -- they're greatincrementalists. And thus, any area of academic study wheresheer horsepower and tenacity are required, the Japanesehave an excellent chance of creating a breakthrough.Traditionally in industry this has meant materials science,but now body chemistry can be added to the prize ring. We expect a number of significant announcements in the areasof genetics, cancer diagnosis, stem cells, and similaravenues of biotech research.
