Beware – Asia stock markets sneeze and Europe catches a cold

Can the recent weakness in the Chinese stock market act as a harbinger of bad news given that two weeks ago, in an effort to boost exports, China’s central bank devalued the yuan?

As can be expected there was a knee jerk reaction in Europe since investors feared that a cheaper Chinese currency would make exports more competitive.

Last Monday it came as no surprise that the FTSE 100 was in negative territory after the steep falls suffered on Asian markets. Perhaps it has been a long time since the drop in Europe was so severe, with investors suffering losses and the index falling almost 4.5% to 5,914 points – the last time it fell below 6,000 was in 2013.

Such vulnerability was not universally expected as some commentators thought Europe is Teflon coated yet it suffered its biggest fall in mining companies that rely on demand from Chinese manufacturers for their coal, iron ore and other metals exports. Glencore, the giant commodities trader and miner, fell 8% and Anglo American and BHP Billiton each lost more than 7% of their value. Apart from the London market, one was also shocked to see Germany’s Dax index fall more than almost 5%, matching the same drop in the French CAC index. 

It does not rain, it pours when Asia markets suffer, as one notices how the Shanghai Composite Index – China’s benchmark stock index – closed down 8.5%, concurrently the Xinhua news agency admitted that China was facing a “Black Monday”.

At the same time that we witness the crash on the stock market in China we can observe the sudden change of fortunes on the Tokyo Stock Exchange. For a few months we did observe a big rise on the Japanese stock market.

Now, the bull market in Japan is the biggest not only in Asia, but also in the world. The prospects for investors in Japan look far more attractive than at any time since the bursting of the Japan bubble. While the experts warn against investment on stock markets in China, India and Iran, they notice that it’s a good time to invest money in Japan.

What is the Japanese secret for the improvement in investor sentiment? Why does Japan stand out significantly different from other Asian countries? In this article I will try to take a look at the gradual rise on the stock market in Japan and try to find the causes of this rally.

No one can disagree that Japan is a developed Asian country which was among the first to join the club of big economic players in Asia. It is one of the most developed countries in the world and its economic power is impressive when compared to other Asian countries such as China, India and Iran – these are still considered as emerging.

The Japanese economy is known as a cradle of innovation, in short a place where one finds the latest technologies.

One cannot omit to be impressed by Japan, with its large automotive companies – all hosting their main offices and factories such as Toyota, Honda, Mazda, Mitsubishi, Nissan, Subaru.

Apart from that Japan is known also as a homeland for famous brands such as Sony, Panasonic, Hitachi, Toshiba, Nikon, Canon etc.

There is no country in the world other than Japan, which boasts such a large number of global corporate leaders that are running companies acting as major exporters of quality products – most of them household names in the West.

No other country has such a high, even similar, well-known brands in the world as Japan, producing high precision equipment that makes it the fourth largest exporter in the world (following China, United States and Germany). What is also remarkable is the perception that Japanese products are believed to be reliable, solid and manufactured under proper franchise agreements in contrast to certain Asian products which are usually considered as fakes.

Japanese companies have a 37.3% global market share in aggregate which, as can be expected, includes hybrid technology as an area of expertise, apart from building of sophisticated electronic components used by the current leaders such as Apple and Samsung.

Another important aspect which distinguishes Japan from other Asian countries is its political hegemony. Whilst the majority of Asian countries can be classified as falling under the rule of strong authoritarian governments, Japan is a parliamentary monarchy with a bicameral, elected parliament headed by the Prime Minister who holds the real power in the country. The Emperor holds a mainly ceremonial and representative role with no real influence over state government.

Having suffered extensively during the Second World War, the Japanese government had wasted no time to adopt a very active economic policy. The model used was that of a market economy coupled with interventionism, which means support from the state for capital-intensive projects such as the construction of roads, railways or research.

To catch up with the rest of the developed world, Japan allocated a high rate of 3% of its GDP to support research activities, which as a result helped it to gain one of the top places in this regard.

With phenomenal growth already in 1967, Japan became the second economic power in the world. A three point plan consisting of a devaluation of the yen, coupled with reduction in wages index and a doubling of labour productivity have helped Japan overcome the oil crises of 1973 and 1979, and result in growing exports yielding a surplus in foreign trade during the first half of the 80’s.

The Japanese economic miracle ushered in the gift of universal prosperity and wealth which was accompanied by low interest rates albeit rampant property prices. The so-called “Soap economic bubble” burst in 1991, when the Japanese securities market had collapsed, losing half its value, forcing Japanese banks to raise interest rates.

The ensuing  deep recession was felt during the 90’s, which contributed to many high-profile bankruptcies and resulted in considerable public debt. The solution to turn the tide to combat such a deep recession was for the Bank of Japan (BOJ) to tighten monetary policy, with the beneficial result that by late 1991, the over heated property market started to stabilise. 

Now, after almost 23 years since the bursting of the Japan bubble, and this week’s sudden drop in Chinese markets one prays for a significant economic recovery and stability of asset values on the Asian stock market.

In Japan, the economic medicine is being masterminded by Prime Minister Shinzo Abe, who was re-elected in 2012. His politics commonly known as Abenomics include three elements: bold monetary policy (monetary easing); flexible fiscal policy (fiscal stimulus); and structural reforms and growth strategy that encourages private investments.

On one hand, the weakening of the yen had a remedial effect on exports and imports, helping to boost employment and growth, albeit inflating internal prices. But, awkwardly, this weakness acts as a threat for foreign investors at the time they wish to convert their profits into their original currencies.

With the yen losing more than 30% of its value against the US dollar and sterling, the excess returns obtained from investing in Japanese equities can be severely reduced or even impaired. But when we compare the Nikkei’s performance during the Abenomics period with those of the S&P 500 and FTSE 100, we see an outperformance of 61.3% and 96.8% respectively, which even after discounting for the weaker yen, still represents a massive turnaround.

To conclude, while we observe large declines on the stock markets in Europe and other countries in the world, at the same time there is a healthy rally on the Tokyo Stock Exchange. Since 2012 the most important index in Asia, the Nikkei 225, has more than doubled and now is rising faster than other indices in the West.

Most experts concur that it is mainly caused by Abenomics, the politics of quantitative easing which has seen the improvement in the Nikkei 225, reflecting the devaluation  of the yen.

One augurs that the good tidings in Japan continue in the short term to boost exports and consequently improve its external trade balance. Can China follow suit and after the recent correction in its growth trajectory once again continue in the path of exemplary growth in exports to new international markets. Only time will tell if the Chinese dragon will grow stronger and regain its dominance as a world exporter of quality products. 

Anna Halas is a research assistant at PKF Malta, an audit and business advisory firm