Japan suffers big sell off

The Nikkei reversed its recent strong run of form in May, sliding 10% over the month to leave it the worst-performing developed market index,barring the German Dax.

Japan’s markets were driven down by the fear that the country’s export-led recovery could be derailed by the difficulties in the eurozone.Ostensibly, much of the economic news from Japan was good. First-quarter nominal GDP growth of 1.2% marked a second consecutive quarter of growth – a rarity in Japan. The figures showed an improvement in exports to emerging Asia, particularly for new cars and high-tech products, reinforcing the view that Japan may be an increasing beneficiary of Asian growth.

However, the problem is the continued reliance on exports. Only a tiny proportion of the pick-up in GDP could be attributed to private consumption despite a rise in salaries as deflation continues to push the Japanese to hoard cash rather than spend it. The new government has introduced a Y13,000 (£95) monthly child allowance payment, designed to boost consumption. As the first of its kind, it may have the desired effect and stop the Japanese saving rather than spending, but history suggests this is unlikely.
There is a question mark over the continued strength of exports. Although the Japanese economy is more geared to the strength of the US and China, the eurozone is still an important market for its goods. As a result, the Japanese economy may slow between April and June because exports are not sufficiently supportive of growth.

The real hope for the Japanese economy may come from its monetary policy. The government may continue to operate a loose monetary policy through low interest rates and quantitative easing just as many other governments are tightening. This should finally weaken the stubbornly robust yen, support the exporters and help with debt financing.

The government is due to reveal its fiscal consolidation plan in June. The IMF has said it is “critical” that a credible plan is formed. Government debt is still vastly higher than for any other developed country and while the government is still in a position to service the debt for the time being, the situation is unsustainable in the longer term.

Japanese funds, in contrast, are still riding high. The average fund in the Japan sector has returned 11.9% for investors, over the year to date. The smaller companies sector has done even better, returning an average of 13.7% since January, leaving it comfortably the best performing sector in 2010. The UK All Companies sector, by comparison, has fallen 4.88% in that time.