International | Aug 15 2008
By Chris Shaw
As with most economies around the world there have been signs in recent month the Japanese economy is slowing. The Daiwa Institute of Research suggests the world’s second largest economy may have actually peaked late in 2007 and is now entering a recession.
Institute economist Mitsumaru Kumagai sees a number of factors threatening the economy’s growth, including the increase in commodity prices in recent years, ongoing concerns over the health of the US economy, increasing inflationary pressures and uncertainty with respect to the outlook for the US dollar.
While all these factors are important, Kumagai suggests it will be commodity prices that hold the key to the outlook for the Japanese economy in the medium-term. The best scenario would be one where prices gradually adjust and the oil price settles at around US$100 per barrel. Such an outcome would likely see the US dollar strengthen at the same time as Japanese stock prices rebound on higher earnings.
If commodity prices were to rally further, he suggests it would have negative implications for Japanese corporate profitability. Shares prices would continue to decline, while bond prices would rise. However, a significant fall in prices could see the global money flow reverse and this could have grave implications for global share prices and the global economy as a result.
Assuming further highs in commodity prices, with oil challenging US$150 per barrel, would not be positive for Japanese stocks despite the perception they are well placed in an environment of rising inflation. Kumagai argues such an environment would be a definite negative, as only a small part of Japan’s inflation is due to a stronger economy, with the rest due largely to higher energy prices.
This means if inflation were to continue pushing higher there would be no guarantee Japanese demand would push higher as well, particularly as wage growth is not keeping up with price increases. As well, Kumagai notes the Japanese economic structure is one where corporations are presently finding it very difficult to pass on these higher costs, so putting corporate earnings under pressure.
In contrast, he suggests if commodity prices can stabilise it would allow companies to adjust, as the poor level of profits in the manufacturing sector to date has been the result of declining profit margins, as there has been no way of offsetting higher input costs. Any fall in input costs via lower or stable commodity prices should therefore translate into stronger earnings going forward.
A significant fall in commodity prices would likely prove to be too much of a good thing in Kumagai’s view, as it would see a reversal in the flow of capital from the UK to the US that has to date helped prop up the US current account deficit.
If this was to reverse via a process of repatriating capital out of the US, it would likely cause share prices to collapse around the world, which clearly would flow through and impact on not only the Japanese market, but its economy as well.
