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Japan’s Most Valuable Resource is Vanishing

In 2013, one of the hottest trades was to get long the Japanese stock market. The iShares MSCI Japan ETF (EWJ) rose 25% for the year, and the WisdomTree Japan Hedged Equity Fund (DXJ), which hedges its yen currency exposure, rocketed 37% higher.

The market’s strong performance was fueled by Prime Minister Shinzo Abe’s policies, popularly known as Abenomics, which inspired optimism that Japan could finally defeat deflation and economic stagnation.

As the idea of Japanese resurgence gained popularity, the funds’ assets swelled. Take a look…

However, there’s one major problem… Abenomics has failed.

Through quantitative easing and large budget deficits, Abenomics has produced currency weakness and higher stock prices… but it’s failed to generate real wage growth.

Currency weakness has contributed to soaring energy prices, and the recent sales tax increase will effectively exacerbate inflation and crimp consumer spending. So despite an escape from the jaws of deflation, problems persist in Japan.

In fact, it’s likely that Japan has stagnated because of 15 years of zero interest rate policy (ZIRP), not in spite of ZIRP. Plus, massive deficit spending over the same time period has led to a seemingly insurmountable government debt-to-GDP ratio of 240%.

Now, I could go on and on about the problems in Japan, but they all pale in comparison to one in particular.

You see, the world’s third-largest economy has a resource problem… and I’m not talking about a lack of oil or copper.

Little Hope for the Future

Indeed, Japan has a scarcity of the most precious resource… children.

Children under 15 make up just 12.8% of the Japanese population, the lowest ratio among nations with populations of at least 40 million people.

Data from Japan’s Ministry of Internal Affairs and Communications shows that the number of children under the age of 15 has decreased by 160,000 in the last year alone. And according to the World Bank, the Japanese fertility rate is among the lowest in the world at 1.41 births per woman, which is a big reason why the Japanese population has been in decline since 2004.

This is a major predicament. As John F. Kennedy succinctly stated, “Children are the world’s most valuable resource and its best hope for the future.”

That’s because, besides being cute, kids also grow up to become productive members of society. They’ll eventually join the labor force, pay taxes, and consume goods and services. The youth of today are the innovators and leaders of tomorrow.

Unfortunately for Japan, the trend of declining population looks like it may continue indefinitely. According to the Japan Family Planning Association (JFPA), 45% of Japanese women aged 16 to 24 “were not interested in or despised sexual contact.”

This fact alone shows just how intractable Japan’s baby shortage may be… And it’s one of the primary reasons why we should be pessimistic about the Japanese economy in the long term.

After all, labor force growth is crucial for economic growth, and destroying the Japanese yen and creating consumer price inflation won’t solve the country’s demographics problem or other structural issues.

The Japan resurgence trade was a winner, but it was just a trade. Unfortunately, as the chart above indicates, many investors may still be overweight Japanese equities.

With a trailing 12-month dividend yield of just 1.2%, EWJ doesn’t offer much in the form of investment income. DXJ is better with a yield of 2.7%, but you’ll have to contend with higher volatility.

Finally, don’t lured by the supposedly cheap valuations of Japanese stocks that strategists keep telling us about. The truth is, there are far cheaper stock markets around the world. If you’re looking for global value, the Cambria Global Value ETF (GVAL) is a much better, and more diversified, pick than DXJ or EWJ.

Safe (and high-yield) investing,

Alan Gula, CFA