Japanese officials are facing questions regarding the record-breaking surge in the Nikkei 225 Stock Average over the past year, reaching levels higher than in 1989 despite a 2% contraction in gross domestic product. The weakening GDP has persisted for three consecutive quarters, with private construction and capital spending remaining stagnant. The tourism sector is thriving due to a weak yen, suggesting that the economy may be even worse off without this factor.
The rally in Japan’s stock market can be attributed to various factors, including corporate governance upgrades implemented over the past decade, the safe-haven status amid global geopolitical risks, and an aggressive quantitative easing program that injected liquidity into the market. However, the effectiveness of these measures may be reaching a plateau, with investors seeking further policy reforms beyond what has already been implemented.
Prime Minister Fumio Kishida faces low approval ratings and may struggle to implement new reforms to boost productivity, cut bureaucracy, or empower women in the workforce. Additionally, Japan’s reliance on exports makes it vulnerable to economic fallout from escalating trade tensions between the US and China. The country’s long-standing zero interest rate policy could also pose risks to the economy, especially in light of stagnant private consumption and declining exports.
Former BOJ Governor Kazuo Ueda attempted to normalize rate policies, following a period where the central bank nationalized the markets and became the main buyer of Japanese stocks. The challenge now lies in weaning the economy off monetary steroids without causing adverse effects. With Japan facing the possibility of another recession and deflationary pressures from China, the BOJ may struggle to make significant policy changes in the near future.
Despite the Nikkei’s impressive rally in recent months, concerns about the sustainability of economic growth persist. Private consumption has declined for four consecutive quarters, exports have plummeted, and inflation is outpacing economic expansion. While the stock market may continue to perform well in the short term, the disconnect between financial markets and economic fundamentals remains a cause for concern as Japan approaches the middle of 2024. Investors are keen to see whether the government can implement new policies to address these challenges and support long-term economic growth.
