Welcome to Thoughts on the Market.
I'm Seth Carpenter, Morgan Stanley's Global Chief Economist and Head of Macro Research.
And on today's episode we're bringing you a live taping direct from Morgan Stanley and MUFG's Japan Summit to discuss the macroeconomic overlook and, in particular, Japan's moment reflation, reform and the case for a structural re-rating.
I am joined by Chetan Aya, our Chief Asia Economist, Takeshi Yamaguchi, our chief Japan economist.
Jonathan Garner, our chief Asia and EM equity strategist.
Koichi Sugisaki, who is our head of Japan macro strategy.
And Sho Nakazawa, who is our Japan equity strategist.
I will say we have just collectively published our mid-year outlook.
So twice a year, Morgan Stanley Macro Research puts together our forecast.
We take the time to debate with each other, to pressure test our views on the outlook for the next year and a half to two years.
And I have to say this version of the outlook process may have been the most difficult one that I can remember, and in no small part because one of the key, fundamental drivers of the outlook globally for growth, for inflation, is oil, oil prices, and the swings there have been pretty dramatic.
And so, as a result, we put a lot of effort into not just our baseline forecast, but also scenarios and the ways in which our baseline forecast could be wrong.
But Chetan, let me start with you.
Tell us a little bit about the exposure in Asia to the energy shock.
So Seth, you're right.
Asia is one of the more exposed part of the world.
But I would say that we've been surprised in the way this energy shock has been managed.
One is, of course, at the global level, Two big swings happened.
U.S. exports increased dramatically by 3.8 million barrels per day.
Just to give you a perspective, global consumption of oil is about 100 million barrels.
So it's a simple math in terms of how big this number was.
And then China, parallelly, also reduced its imports by 3.5 million barrels.
So we had a 7 million battle swing from a global oil demand balance perspective.
And secondly, as far as gas is concerned, that is where actually we were more concerned about Asia, because Asia was very dependent on Middle Eastern gas.
And on that front, China single-handedly has bailed out the region.
So China cut its gas imports by about 45%.
And that had at least avoided the shortages that we were worried about.
We can manage oil prices, but shortages is something very difficult to manage.
So that's at the global level.
And within the region.
What every economy did is to switch to an alternative source of fuel, whether it is electricity generated through coal or other renewable sources.
And particularly that happened in China and India, which are the two big importers of fuel in the region.
And then additionally, what we also saw is that everybody managed the fuel price increase quite well.
So on an average, if I look at the stats as of today, only about 25 to 30 of the underlying fuel price increase has been passed on to the consumer.
So the governments are taking it.
So there is a burden on the fiscal front that is building up.
But as far as the consumers are concerned, this has been a help.
And therefore, you have not seen a big spike in inflation across the region.
Okay, so a lot of comments about Asia in general.
Let's go more specific to here in Japan.
And so Yamaguchi-san, you were an early adopter of the Japan reflation view.
If we go back a year, two years, three years, you were probably more optimistic, more bullish about growth in the market than consensus.
More recently, you've been a little bit more cautious about where growth is going.
And so can you tell us a little bit first why you're a bit more cautious now relative to where I suspect the market is?
And then when it comes to the energy shock, how do you see it playing out with the Japanese economy?
And should we worry about it derailing this whole reflation trade?
We think Japanese underlying economic fundamentals remain resilient, in the sense that nominal GDP recovery will continue as a trend.
But for this year I think there is a short-term slowdown, both in terms of real GDP growth and nominal growth.
GDP growth due to the terms of trade shock.
So far, thanks to the government energy subsidies and Japan's relatively large strategic oil reserves, the direct impact on households has been limited.
But we are already seeing a big increase in producer prices in the April data.
It jumped to 49 YOY and we expect this producer price index will continue to go up due to the higher oil prices, but also because of the NAFSA-related supply-side disruptions in areas such as construction materials, plastic products and industrial solvents, and so on.
That said, we still believe that underlying economic fundamentals remain resilient, in the sense that there is a structural labor shortage.
So wage growth may somewhat slow.
But still, I think a solid base up increase will continue next year, especially among young workers.
Also, I think this structure of tight labor market encouraging companies to step up labor saving investment.
And I think, together with government's initiatives for domestic investment, I think domestic capex will also likely remain resilient.
So next year we think this year for nominal GDP growth we expect slightly negative growth due to the terms of trade laws.
But the next year, we are expecting above 4% nominal GDP growth.
So the overall story remains unchanged, despite the short-term headwinds.
Okay, so fundamental story remains unchanged.
We're pretty optimistic, but it's a matter of long-term versus short-term.
Jonathan, let me turn to you.
Equity markets are generally optimistic, I would say, these days.
But there is a bit of a divergence between views on equities here in Asia, between Japan on the one hand and EM overall.
In the Mid-Year Outlook, you have expressed a preference for Japanese equities over EM.
Can you talk a little bit about that view?
Why that preference?
Are there sectors or specific stocks that matter more?
How are you thinking about this sort of allocation across equity markets for you in Asia?
So certainly, as Seth indicated and Chetan and Yamaguchi-san said, it's really an environment where the sector call, particularly the CapEx super cycle call, should drive portfolios.
And that naturally leads you, in Asia, more to North Asia, where Japan is very richly endowed in beneficiaries of the capex super cycle and obviously, markets like Korea and Taiwan, and much less so to South Asia, where the larger markets are much more populated by consumer and services stocks.
So in our portfolio we're essentially overweight capital spending, underweight the consumer And when you look at the Japan market, one of the things that my colleague, Daniel Blake has done a lot of work is the sort of thematic exposures that exist within our coverage.
The four core Morgan Stanley research themes of multipolar world, AI tech diffusion, future of energy and societal shifts.
They map into about 75 by stock number of our coverage for the Japan market.
And they're quite nicely distributed across the stock coverage.
Obviously, some stocks have more than one aspect to them.
And that is highly advantageous and much more advantageous than, in fact, any other large market.
Of course doesn't have AI tech diffusion or it largely lacks the beneficiaries, the upstream beneficiaries.
The US has legacy sort of software service business models and consumer exposure.
Now, it's not to say that all is sort of rosy in the garden.
There are large auto OEMs here in Japan, where the earnings numbers are challenged.
So it's all about the kind of the dispersion that's going on within the portfolio.
But just on the base, case targets 4304 topics.
That's set by Nakazawa-san and myself.
It's about 12 upside in the base.
In the two weeks since we published the report, EM has fallen back somewhat.
So there's about 8% upside to our EM target.
But on a kind of risk adjusted bull bear skew.
Bear in mind that EM is much more skewed in terms of the earnings drivers of that market.
Essentially, if you strip Korea and Taiwan out, there's no earnings growth in the EM right now.
You would ultimately have to favor Japan.
So Japan should be at the core of any Asia portfolio at the moment.
And can you just give us a little insight as to what you're seeing about how the market is or maybe is not, pricing the threat from the energy shock?
What are you seeing in equity markets, top line, down into sectors?
Do you think there's enough concern?
Do you think there's room for that to get sort of re-rated just on the energy shock situation.
So what you're seeing is that anything that is consumer related is really struggling in terms of revisions.
I think there are six different sub-components of the consumer that we can track.
Every single one of them has downgrades and the upgrades are in energy, upstream energy, which isn't that well represented in japan.
There are a couple of names in materials really across the board, in semis and it across the board and broadly tech hardware, and then in the defense capital goods space.
And that dispersion in revisions within the Japan market or within Asia as a whole is something that I've never seen before.
It does maybe to some extent question the resilience of the consumer in terms of the way that the numbers are being downgraded.
So I'll just leave that hanging a little bit.
All right, thank you very much to my colleagues, and this is where I have to shift back into podcast mode to say thank you for listening and if you enjoy Thoughts on the Market, please share it with a colleague or friend today.
Thank you very much, everybody.
That was part one of a special two-part episode from Morgan Stanley and MUFG's Japan Summit.
Join us tomorrow for part two of the conversation.
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