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The annualized 3.7% Q2 GDP growth level may have lifted the world’s second largest economy out of recession according to technical definitions, but if the resulting 3% Nikkei selloff is any indication domestic investors don’t see any catalyst for growth on the horizon even if a bottom has been reached.  

A quick scan of the Cabinet office data shows that government spending has been a primary, if not the sole, driving factor in the rebound. In the chart below the 4Q moving average of estimated public demand is juxtaposed against the 4Q MA annualized GDP rate: While public spending has not yet reflated to the levels seen at the peak during the start of the decade, the trend is clear. With Public debt reaching nearly 200% of 2008 GDP, any additional spending (and keep in mind that a victory by the opposition Democratic Party at month end is expected to INCREASE government spending programs) adds crushing incremental principal to a balance that is only manageable due its zero rate/domestic creditor construct.

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We have remained bearish on future prospects for the Japanese economy since opening our doors, and I have often compared it to a man treading water with a bowling ball in his hands. We are currently short the Japanese equity market via the EWJ ETF, but we reserve the right to opportunistically book profits as we head into the final phase of the election: even in a country with as many problems as Japan, optimistic euphoria can take hold when a new government takes office with a fresh mandate.  If we take history as our guide however, the euphoria won’t last if the new boss can't deliver.

Andrew Barber

Director