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The Nikkei Surges, but Will Japan Stagnate?

If there's no arguing with success, then investors in Japan's surging stock market have had little to complain about recently.

The Nikkei (NIKKEIINDICES: ^NI225  ) index has surged nearly 8% in the past month and more than 20% over the past three months while significantly outperforming the S&P 500. Analysts and shareholders alike have celebrated new Prime Minister Shinzo Abe's pledge to open fire on the struggling economy and the strong yen with stimulus injections and inflation targets. He's got one half of that down, having approved a massive public-spending initiative in excess of $100 billion. And in pressuring the Bank of Japan to print money, he's hard at work on the second half.

Shinzo Abe walks a fine line with his plan, however -- a line between giving Japan's economy the boost it needs and crushing it beneath even greater burdens of debt.

Breaking down Japan's stimulus
Abe's plan is broad in scope yet simple to understand. About 3.1 trillion yen -- out of the 10.3 trillion yen the central government will provide -- will go toward boosting private investment and other measures. Another 3.8 trillion yen will cover disaster relief and preparedness following 2011's tsunami disaster. The rest will cover all sorts of measures, but expect plenty of public-works spending and infrastructure repair.

While this seems great in theory, keep in mind that Japan has already tried stimulus packages numerous times in recent history. Throughout the 2000s alone, Japan unloaded 45 trillion yen; for those efforts, the nation's average economic growth rate was only 0.8% through that decade. The government used public spending to combat the "Lost Decade," with plenty of public-infrastructure investments that only added to the country's astronomical public debt load of 224% of GDP.

This new round of stimulus could add 3% or more to the country's GDP, and it comes combined with Abe's tough pressure on the Bank of Japan to ease monetary policy. The yen has remained strong against the dollar for quite a while, hurting exporters. Japan's current account balance is currently headed toward negative numbers -- something unthinkable just a few years ago.

A bold gambit by a debt-laden economy
Will it work? That's the question everyone, from economists to investors, wants to know of this massive measure. Unfortunately for Abe, Japan's economy is just as capable of falling into debt purgatory as it is of seeing a recovery sparked by the stimulus measures.

So far, Abe and his Liberal Democratic Party have shown little willingness to actually pay for all this stimulus. Japan wants to approximately double its consumption tax, which would add 12.5 trillion yen a year. But that would hardly cover Abe's ambitions of public-works stimulus of 200 trillion yen -- a goal the new prime minister mentioned back in November, before his party won the recent election. While that might not happen, raising the consumption tax in the midst of Japan's sluggish growth seems like a poor move to incite growth and spending.

The rest will fall on bond sales and other debt-loading measures, presumably. That's not good for the country with the highest public debt load in the world, and it gets worse for Japan. If this latest move can't stimulate the economy to long-term higher growth rates, Japan will be faced with an aging population and fewer taxable young workers in the years ahead -- a toxic combination that will stretch the government's ability to keep the economy churning.

In addition, the stimulus needs to go to programs that actually will move the economic needle. Public-works programs are nice in theory, but it's doubtful they'll encourage Japanese growth in any meaningful amounts, considering their failures to do so during past stimulus packages. Boosting private investment will help, and pushing for looser monetary policies to get Japan's exports back on track is a key part of this entire movement, but it seems doubtful Abe's plans will push his country toward the long-term high growth it so desperately needs.

More likely, Japan will hit a short-term economic surge, with markets and stocks soaring from the injection of easy money. Similar movements have followed other worldwide stimulus incentives; the U.S.'s quantitative-easing packages, in particular, have been highly effective in jolting stock markets. In the long term, however, Japan likely will face a shortage of productive workers and a crippling debt burden down the road. Many analysts predict that Abe's stimulus will create far fewer jobs than advertised -- a result that would slam any revenue-generating measures the government creates to compensate for the move.

Unless everything goes perfectly according to plan, years from now Japan could face some tough decisions on how to navigate a dangerous economic future.

The near-term boon for investors
Fortunately for investors, the near future should provide plenty of optimism.

Abe's pressure on the Bank of Japan should help out export-heavy companies, such as automakers Honda (NYSE: HMC  ) and Toyota (NYSE: TM  ) . Toyota and Honda have been crushing the U.S. market recently, leading American car sales higher. A weaker yen will make every dollar earned in the U.S. worth more in Japan, boosting these companies' profits and helping to push their stocks higher.

Ditto for electronics company Sony (NYSE: SNE  ) . The Japanese tech powerhouse's stock is down more than 8% over the past three months, but a weaker yen would greatly help the company later in the year, when many expect the company to release its PlayStation 4 gaming console. Sony operated at a net loss last year, and turning things around on its bottom line could greatly improve its outlook.

The stock the stimulus might help most is Nomura Holdings (NYSE: NMR  ) , however. Shares of the financial company have been on a tear recently, rising more than 60% over the past 52 weeks. Loose monetary policy and an influx of government dollars would likely push Nomura to even loftier heights, particularly with Abe's party so keen on giving a lift to private investment.

The line between short term and long term
The short-term outlook smiles on investors: Stimulus should push markets up, and Japanese stocks should take off if Abe is successful in its inflation targets. A weaker yen will help exports, and Toyota, Sony, and others should benefit.

In the long run, however, Japan could well be mortgaging its future. The Japanese government will have to handle its debt eventually, and if it puts off such an obligation until its population is even older and more lacking in productive young workers, it'll be far more difficult to clear that hurdle. Investors should cheer on Abe's stimulus move for now, but looking at the big picture, any deviation from what Abe and his party want to achieve could leave Japan in a severe economic crisis.

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9/30/2016 10:08 AM
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