Japanese lessonsby Andy Davis / September 19, 2012 / Leave a comment
Published in October 2012 issue of Prospect Magazine
The Akihabara district in Tokyo: still glowing after two lost decades Japan is one of the most fascinating places on the planet. The culture, history and urban vision are all absorbing—but the pointy-headed finanace-nerd in me is intrigued by another possibility: the chance to meet people who live and work in a place that suffers from the deflation that central bankers in the west are working so hard to fend off. Even on the most broad-brush numbers, Japan’s recent economic history stands out—many of its core indicators have registered extreme readings relative to other developed countries for a long time now. Inflation hasn’t been above 3 per cent in two decades and for much of that period prices have fallen or remained static. Economic growth has been weak, slowdowns frequent, and you have to go back 13 years to find the last time Japanese 10-year government bonds yielded 2 per cent or more. As low growth and mounting debt burdens have settled across the western world, plenty of people are wondering whether Europe might fall into the same trap as Japan. Preparing to visit has prompted a lot of thought about growth around the world and the bets that investors are making. A couple of things seem clear. First, the swelling numbers pouring their money into corporate bonds and bond funds are implicitly making a powerful statement about how they view the future. The only rational basis on which to buy bonds that have already become this expensive, and whose yields therefore have fallen to such long-term lows, is that interest rates and inflation are going to stay low for a long time yet. So the rush into bonds tells one of two stories. Either investors are pessimistic about the outlook for growth (if they weren’t, why would they buy bonds whose prices would fall if growth and inflation picked up and interest rates therefore needed to rise?). Or they are simply ignoring these longer-term dangers and are settling for the bird in the hand: an acceptable return today, regardless of the ultimate risks to their capital. Another popular option is to invest in the shares of large, multinational companies, which provide reasonable capital protection and reliable dividend income. The ideal here is to buy shares in companies with attractive and sustainable yields and to benefit from their “progressive dividend policy.” This amounts usually to an assurance from the directors that the dividend will rise each year at or above inflation—most investment commentators agree that large global providers of consumer staples, from cigarettes to soft drinks, are among the best places to look for this kind of investment. But if we buy equities in order to benefit from a progressive dividend policy, we’re assuming that there will be sufficient economic growth to allow this company to pay out a rising stream of dividends well into the future, and that even if such growth doesn’t materialise, it is capable of growing faster than a moribund global economy and will therefore be able to keep its promise. To some extent, growing demand for dividends has changed companies’ behaviour. So some of the 12.2 per cent point increase this year in dividend payments (Capita Registrars, the provider of share services, forecasts the total will rise to £76.3bn in 2012) will represent a one-off effect as boards adjust the proportion of profits that they pay out. Another factor in the increase will be companies’ relative lack of demand for investment capital to fund expansion, which therefore frees surplus cash for other purposes such as dividends. Neither of these short-term factors that are pushing up dividend payments is necessarily a guide to the future. Instead, the judgement at the heart of the case for buying these shares is growth. What do I believe about this company’s capacity to grow? And at today’s share price what assumptions am I making? The bond buyers are asking these questions and appear to be arriving at pessimistic conclusions. How and why do we start and stop believing in growth? The Japanese have been wrestling with this question for over a decade. I look forward to writing further about this question in these pages.