With the Japanese consumer price index understating deflationary trends, the lack of pricing power i...
With the Japanese consumer price index understating deflationary trends, the lack of pricing power in the construction and retail sectors may be worse than headline rates imply.
Jonathan Greig, director Japanese equities at SG Asset Management, says the construction sector is particularly badly hit as bloated government spending is now being cut back, leaving too many businesses fighting over too few contracts.
Oversupply is also blighting the retail arena, he says, damaging pricing power as the Japanese consumer continues to appear nervous.
Steven Bell, chief global economist at Deutsche Asset Management, says there has been a cyclical bounce in production but Japan continues to labour under severe structural problems that need to be urgently addressed.
He adds: 'Deflation is very bad news for the country, although the weaker exchange rate is welcome as it helps exports and the world economy.'
The importance of dealing with the structural issues driving deflation is even more pressing, according to Fraser Chalmers, head of Japanese equities at Standard Life Investments, as official figures understate the deflationary problem.
He says: 'When you consider that the consumer price index probably still overstates inflation, then the deflationary problem is even greater.'
Deflation in the region was caused by the economic bubble in the late 1980s, says Greig. 'Since then, demand has fallen away and there has been a loss of pricing power among suppliers,' he says. 'Japan went on a capital expansion spending spree, which has unravelled itself in the shape of deflation.'
If there is a loss of pricing power that cannot be passed along the line in terms of cheaper costs it affects profitability and makes a portfolio manager's job that much harder, says Greig. 'Deflation is not fixed at the moment,' he adds. 'What we need is a pick-up in demand and some excess capacity.'
Chalmers says the Bank of Japan must be at the forefront of any policy change to deal with the problem. He says: 'It has said it will ease monetary policy but would prefer to see other policy changes first. Bank loans outstanding are still falling and the link between monetary growth and credit growth seems to have broken down.
'Recently, speculation has grown about the bank adopting the more unconventional method of foreign-currency bond purchases. This would mean it could exert downward pressure on the yen, which would further benefit economic growth and stem the deflationary cycle.'
Greig cites the construction, retail and property sectors as the most hit by deflation in Japan.
'The construction sector was expanded to meet huge government projects, which have since been cut back,' he says. 'As a result, construction companies are competing madly to supply to market. Retail companies are over-supplied and basic food and clothing businesses have been severely affected in terms of massive price cuts.'
Although it is a stockpickers market, Greig is invested in domestic-driven areas of the market: exporters, financials and the more defensive utilities and food sectors. Chalmers is underweight financials and overweight pharmaceuticals.
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