Unflattering comparisons have been made in recent years between Germany and Japan. Japan, once the darling of the global economy, has been in the doldrums for years and Germany has been viewed as heading the same way. The economic underperformance of these two countries against the pacesetter in the global economy - the US - can be demonstrated by the fact that, since 1995, real GDP in the US has growth by almost 40%, compared to 15% in both Japan and Germany.
Despite the tawdry longer term economic data, two of the best-performing major equity markets so far this year are Germany (up 15%) and Japan (up 13%), against a backdrop of flat US equity prices. The reasons for the significant relative outperformance are numerous but at the heart of those adopting a more bullish longer-term outlook is the belief that fundamental reform will be forthcoming in these two former economic powerhouses. Optimists view the recent and upcoming elections in these two countries as a catalyst for change.
Significantly, both Germany and Japan have, economically, been performing poorly for some time. Germany has struggled with integration of East and West and suffered through a lack of competitiveness in its export sector.
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Over recent years, Germany has, however, undergone a painful period of competitive devaluation of domestic wages against European competitors, reflecting an entry level into the euro at too high an exchange rate. Japan, like Germany, has suffered from deficient domestic demand and has spent the last fifteen years working off the excesses of the bubble in the stockmarket and real estate, suffering persistent deflation and periodic recessions.
The outcome of the election in Japan is now known, with Koizumi's LDP Party winning by a surprisingly large margin. The market is now up 10% since the election was called, back in August, and has set new four year highs (on record volumes) in recent days. Investors have taken the view, rightly, that a cleansing of the 'old guard' from the ruling LDP and a sizeable majority will give Koizumi a clearer mandate to sell off state assets through privatisation of the Post Office. The excitement caused by this planned move on would be surprising were it not to represent the liberalisation of one of the world's largest financial institutions and represent a significant step towards more efficient resource allocation in Japan.
It would be misleading to overstate the near-term tangible impact of Koizumi's victory, given that he had been in power for the previous four years and, to date, the reform process has been positive but painfully slow but a clearer mandate for more significant change is welcome.
In Germany, Merkel, the challenger, still looks set to replace Schroeder as the new Chancellor but her party's (CDU) lead in the polls has been slipping, suggesting that a grand coalition, with an alliance between the incumbent SDP and CDU, could be on the cards.
As in Japan, short term political impetus, with a new ruling party in Germany, could throw further fuel on the fire for those playing the reform story. Germany and Japan both show, however, that politicians can, and will, only do so much. The corporate sector is driving developments and, for equity investors, the outlook for earnings will still depend on the continuation of progress as management implements change.
By Paul Niven, Head of Strategy at F&C Asset Managemen
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