The coronavirus has been taking a toll on China, but its neighbors are also feeling the effects of the outbreak. Japan is certainly not shielded from it, although the bull/ bear debate on Japan has been going on since well before the coronavirus was reported.
A weaker-than-expected GDP reading for the fourth quarter had many investors leaning bearish on the Japanese market, but it seems the tide is starting to turn. So is now the time for the bulls or the bears to come out in Japan?
Q4 2019 hedge fund letters, conferences and more
Bulls / bears on Japan: coronavirus impacts
The biggest factor in the bulls/ bears debate on Japan right now is the coronavirus. In a report dated Feb. 17, Nomura analyst Takashi Miwa set out three scenarios for the impact the outbreak will have on nations around the world, including Japan.
His base case assumes that major Chinese cities remain locked down until the end of February. In this scenario, he estimates that Japan's annual real GDP will shrink 0.5%. That's 0.7 percentage points below his previous forecast and includes both the coronavirus impact and the weaker-than-expected fourth-quarter GDP number.
His base case assumes a decline of 42 percentage points in inbound tourist arrivals and tourist spending. It also assumes a drop of 10 percentage points in exports to China during the first quarter. He assumes a similar decline in corporate capital expenditures, although not quite as much as exports. He also predicts a "slightly negative impact" on domestic private consumption.
This scenario assumes a decline of 1 percentage point in overall real GDP for the first quarter. It also assumes a rebound in the second and third quarters, although not enough to recover the demand that was lost in the first quarter.
Miwa doesn't expect Japan's central bank to offer any kind of policy response in his base case. He notes that the Bank of Japan is "running low on additional policy instruments" to address the GDP slowdown. Additionally, the response of the yen versus the U.S. dollar to the coronavirus news has not been significant, so there is some flexibility for the central bank to address appreciation in the yen.
Behind the real GDP decline in Q4
Earlier this week, it was reported that Japan's GDP plunged 1.6% quarter over quarter, which was worse than the Bloomberg consensus of a 1% decline. Since growth in the third quarter was revised down from 0.4% to 0.1% quarter over quarter, output declined 0.4% year over year in the fourth quarter.
Capital Economics economist Marcel Thieliant said in a report dated Feb. 17 that private consumption plunged 2.9% quarter over quarter. The government froze the tax rate on food at 8%, which did help. Spending on services was better, but spending on durable goods plunged 12.8% quarter over quarter. He expects consumer spending to bounce back in the first quarter unless consumer confidence takes a significant hit from the coronavirus outbreak.
In a separate report, Thieliant and fellow Capital Economics economist Tom Learmouth said the two main causes of the sharp decline in manufacturing output for the fourth quarter were the sales tax increase in October and Typhoon Hagibis.
They pointed out that both Japan and Germany saw their industrial production fall in step with each other. This is significant as the two nations both depend heavily on the auto industry for their manufacturing output. Since both nations were affected, they argue that external factors contributed to the decline in manufacturing output.
Bulls and bears on Japan: bonds
According to Thieliant and Learmouth, yields on 10-year Japanese government bonds have been hovering close to the midpoint of the Bank of Japan's "around zero" target this year. Gold priced and Japanese government bond yields have diverged in recent months. However, while demand for gold has increased due to the coronavirus outbreak, safe-haven demand for Japanese bonds has been lower.
The spread between U.S. Treasuries and Japanese government bonds has declined in the last month. However, the yen has not strengthened against the U.S. dollar. The Capital Economics team also noted that equity markets have been holding up fairly well despite the coronavirus outbreak.
Bulls and bears on Japan: equities
The Nikkei has underperformed U.S. equities in the last two months despite the fact that the yen hasn't strengthened against the dollar. Thieliant and Learmouth say that was because Japanese corporate earnings have been weak. However, they believe Japanese equities started the year with attractive valuations compared to U.S. equities. They predict that the Nikkei 225 will rise to 26,000 by the end of 2021.
Investors are starting to notice the attractive valuations in Japanese equities. Nomura analyst Naka Matsuzawa said weekly flow data revealed that foreign investors were "major net buyers" of Japanese equities the week of Feb. 3. They bought ¥791.7 billion worth of Japanese equities in what was the first week of net buying in six weeks.
Foreign investors essentially replaced some of the ¥1.7 trillion worth of Japanese equities they had sold in the five weeks before. Most of the buying was futures, and he believes it was due to the unwinding of excessive hedging.