Credit Cycles

Japan will be first to benefit from global economic downturn

Originally published in the December 2008/January 2009 issue

No one can disagree that a once-a-century event happened in 2008: assets were sold globally by money managers in need of cash, and the de-leveraging storm swept away investors’ appetite for risk.

Now we are seeing clear signs of a global economic slowdown, especially after the “October Crisis,” which seemed to accelerate the credit crunch and economic contraction. Most developed countries are in a recession and the financial market turmoil still lingers.

We believe that tighter regulations for financial institutions will be adopted going forward and the de-leveraging process may continue for a while. Amid this depressed environment, investors may feel that there is no safe place to invest in the world and may even wonder if they are better off holding on to cash. We disagree with that approach. It is our view that there is a silver lining in Japan because of its completely different credit cycle from the rest of the world.

Lack of liquidity has left both financial institutions and non-financial corporates with the need to generate cash. The liquid assets sold off knocked down the Japanese equity market this year. No one had the ability to consider ‘fair values’, and the rush to accumulate cash caused the malfunction of the market pricing mechanism. It is our view that the liquidation was the primary factor for a mispriced market, which led to a widening gap between fundamental valuesand market prices. Most investors still seem to be evaluating the timing for this gap to disappear.

Due to the considerable measures adopted by global central banks and authorities, including the capital injection to financial institutions, we consider that this de-leveraging storm will pass. That said, some investors are voicing concerns that the economic stagnation or severe deflation we experienced during the Great Depression will come back. While we do not deny the possibility of it, we consider that investment opportunities are high enough to take the risks from cash again.

It’s different now
During the Great Depression, the gold standard system, a monetary system of fixed exchange rates in terms of gold, constrained the flexibility of a policy response as there were no Keynesians and Monetarists. The current situation is different. We have accumulated wisdom about finance and economics. Also, we have learnt a lot from the burst of Japan’s bubble economy and the various measures for deflation. Though we may have to endure some pull-backs in long-term economic growth (especially where high leverage boosted the worldwide economies), the fear of a Great Depression type of recession seems overstated. Most central banks and governments took decisive and unprecedented actions in response to the credit crisis: it is an unparalleled reflationary policy in today’s environment. We should not underestimate the global coordinated policy change on a massive scale and we should not have to worry about the return of a Great Depression.

We expect that when this once-a-century price gap between market prices and ‘fair values’ has narrowed, a great investment opportunity will emerge. As Warren Buffett said, “Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors”.

We believe now is the time to be greedy to make the best investment choices. We do not expect global economies to experience a boom anytime soon but, instead, a global recession in the coming few quarters. Once this credit turmoil calms down, we believe that cash will be invested again into the risky assets by those seeking higher returns and the money will then leverage the price movements.

Since global equity markets and economies are affected severely by the credit crunch, there is now a wide range of investment opportunities; but which will be the best for investment? For selecting the assets to invest, we must carefully distinguish the reason why their prices came off in the first place. Some assets are hit because of liquidity and other assets are whipped because of slower growth and potential weakness. Global economic slowdown is the common factor for evaluating every asset, so it will not give us the implication for finding the difference among assets. We believe, going forward, the change in the credit cycle will provide us with many opportunities for allocating the assets in today’s environment.


Fig.1 shows the credit cycles for Japan, US, and UK from 1980 to 2008. The x-axis shows the real house price index which was originally calculated by OECD, and the y-axis shows the debt level compared to the nominal GDP for households and non-financial corporate businesses.

This chart shows an opposite credit cycle between Japan and Western countries. In the US and UK, credit levels rose as real home prices soared. In other words, the debt expansion and real estate prices are highly co-related, and the economies were boosted to the so-called ‘bubble’ level. The plotted points for the US and UK shifted from the left-bottom to the right-up area from 2000 to 2008.

Meanwhile, the debt level and house prices in Japan increased from the 1980s to 1990s. But after the bubble burst in the 1990s, debt level and real home prices continued to decline for about 18 straight years. As a result, plotted points for Japan shifted from right-top to left-bottom area. We consider that both movements for Japan and Western countries are extreme and that Japan and the US/UK are positioned in the opposite cycles. We cannot expect that the leverage will return back to the levels we saw in 2006 or 2007.

However, the current tendency of cash accumulation among investors also seems extreme. The global economy will find a ‘proper’ level of leverage, and global credit creation will return. Given the current leverage level which is shown in Fig.1, the US and UK are required to decrease their debt levels, while Japan has much more room to expand its economy.

The potential is there
As mentioned previously, Japan has the competitive ability for leverage and has huge potential for credit creation. Some may criticise the fact that Japanese managements had retreated with the domestic market, especially during the period of de-leveraging. However, we believe that the recent moves among many Japanese companies show their interest in expanding in overseas markets.


Fig.2 shows the amount of M&A (from Japan to overseas) in US dollars. During the recent turbulence, Japanese companies continued to go abroad to seek growth. The most remarkable case was that between Mitsubishi UFJ Financial Group (MUFG) and Morgan Stanley. MUFJ, one of the most conservative banks in the world, made a prompt management decision to take a major stake of one of the world’s most aggressive investment banks, Morgan Stanley. We could not have imagined such a deal before, even though equities traded at cheap levels relative to their normalised profits.

Among some other cases are that of Takeda Pharmaceutical and Millennium Pharmaceuticals, Tokio Marine and Philadelphia Consolidated, NTT Docomo and Tata Teleservices, Ricoh and Ikon Office Solutions, Daiichi Sankyo and Rannbaxy, etc. We consider that current oversold stock prices offer attractive opportunities to ‘business investors’ who are able to take higher risks relative to ‘financial investors’, prompting them to act more aggressively than before. We believe that these sorts of activities represent a change in the growth scenario for Japanese companies and we expect this trend to continue.

In summary, Japan will benefit from the relative competitiveness of its credit cycle, although the global economy may remain stagnant in the short term. Also, we hold the view that a steady growth among Japanese companies will provide us with an investment opportunity that we have not seen before. In addition to these factors, we consider that the recent reflationary measures among global countries may have some inflationary effect that would provide better rewards for investors.


Shuhei Abe is President & CEO, SPARX Group Co, Ltd. He began his career as an analyst for Nomura Research Institute (Japan) and transferred to Nomura Securities in 1982. He formed Abe Capital Research Inc in 1985 and managed Japanese equity investments for US and European investors. In 1989, he returned to Tokyo to start SPARX Group.