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An optimistic outlook for Japan

It has been a lousy year for the Japanese economy. But it’s clear that a rebound is on the cards.

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Japan's economy is set to bounce back

It has been a lousy year for Japan. An "ugly contraction" in the third quarter saw the economy shrink at an annualised rate of 2.5%, the steepest slide in four years. Capital expenditure dropped by 2.8% in the same period, the sharpest decrease since the third quarter of 2009. The latest quarterly Tankan survey of large manufacturers has revealed that businesses think conditions could worsen in the next few months.

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Nevertheless,"this $5trn economy has been underestimated before", as Pete Sweeney points out on Breakingviews. The data isn't as bad as it seems at first glance, and there are plenty of grounds for optimism. For starters, part of the decline is due to the strongest typhoon in 25 years as well as an earthquake.

Meanwhile, dig into the Tankan figures and it's clear a rebound is likely, says Freya Beamish of Pantheon Macroeconomics. Fixed investment growth by large companies has accelerated to a fresh peak of 13% year-over-year, so we can expect capital expenditure to bounce back in the fourth quarter. The "gradual, but persistent" quickening in wage growth over the past two years isalso worth highlighting. Hourly wages are climbing by 2.6% year-on-year, notes Jonathan Allum of The Blah. Pay growth should fuel consumption, which accounts for around 60% of GDP.

Japanese companies are spending more on automation and robotics in order to cope with the shortage of employees in the tightest job market in decades. The unemployment rate is 2.4%, close to a 25-year low.

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Labour-market reforms have brought more women into the workforce and the government has relaxed its attitude to foreign workers by granting short-term visas for the tightest sectors, including healthcare and tourism. These changes imply a bigger workforce and higher future growth.

Another positive sign is an evident increase in innovation. In 2017 Japanese companies filed 200,370 overseas patents, second only to the US. Improved corporate governance, higher profitability and bigger dividends are also encouraging.

The Topix index's 2.4% yield narrowly eclipses that of America's S&P 500 index. The central bank, moreover, continues to print money, which bodes well for asset markets.

Stocks are on sale

Japan has been deemed a bargain for some time, and now it is even more appealing. The Topix's constituents trade at an average forward price-earnings ratio of 12, a six-year low and a far cry from the S&P 500's 16. Two investment trusts to consider for 2019 are Baillie Gifford Japan (LSE: BGFD) and Fidelity Japanese Values (LSE: FJV).

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