Morgan Stanley
  • Research
  • Apr 21, 2017

How Rising Wages May Help Lift Japan’s Economy—and Stocks

Record low unemployment rates are pushing up salaries, which could catalyze consumer spending, a welcome boost for corporate profits, equities, and economic growth.

After fighting entrenched deflation for decades, Japan may be turning the tide, as falling unemployment pushes up wages, adding momentum to a recovery in consumer demand that could help lift economic growth, corporate profits, and stocks.

Japan’s current unemployment rate, at 2.8%, is at its lowest in 22 years. That factor, along with above-trend GDP growth, could fuel an increase in total employee compensation by slightly more than 2% in 2017 and 2018—in line with nominal GDP growth—while growth in average hourly earnings could accelerate to around 3% in 2018, according to Morgan Stanley Chief Japan Economist Takeshi Yamaguchi, in a recent report. 


The best environment for equities tends to be when nominal GDP is accelerating and the wage share of GDP is stable or declining.

That would be good news for equity investors, as well. Chief Asia Equity Strategist Jonathan Garner expects 26.5% year-over-year average earnings growth for components of the benchmark Tokyo Stock Price Index in 2017, followed by 9.8% growth in 2018. “In a nutshell, we're bullish on Japanese equities," he says, adding that rising wages would most benefit sectors such as real estate, insurance and media. 

Structural and Cyclical Factors

The seeds of the current turnaround were planted several years ago. In January of 2013, after nearly 15 years of trying to beat back deflation, Japan adopted a 2% inflation target, in line with the “three arrows” of “Abenomics”—a policy mix of monetary easing, fiscal stimulus and structural reforms that have been the hallmarks of Prime Minister Shinzo Abe’s plan to turn around the Japanese economy. Yet, despite some initial success from the central bank’s monetary easing and progress in corporate governance reforms, Japan’s inflation rate remains far below that target.   

Falling unemployment, however, could change all that. A tighter labor market would push companies to offer higher hourly wages to attract and retain employees, in a dynamic known as the “Philips curve,” Yamaguchi says.

Structural factors loom large. Japan is on the edge of an inexorable wave of aging baby boomers who are retiring, even as the younger working population continues to shrink. According to Yamaguchi, “There is pressure for tightening from both the demand and supply sides, as the aging population dampens labor supply, at the same time that it gives rise to labor demand for stable growth in healthcare and social welfare employment.”

Cyclical factors also play a role. In 2014, a consumption-tax increase triggered a “mini recession," from which the Japanese economy now appears to be recovering, Yamaguchi says.

For corporates, rising wages can also cut the other way. Employee compensation often accounts for the largest chunk of corporate expenses, so rising wages can dent earnings, without commensurate gains on the revenue side. But Japanese firms are highly capital-intensive, and “upward pressure on wages is also associated with a stronger demand environment and higher nominal GDP growth and, hence, revenue growth," says Yamaguchi. “We think the positives of wage inflation in Japan outweigh the negatives."

Corporates will need to adjust to the new labor-market dynamics. To combat a tightening talent market, companies must focus on improving productivity and operational efficiencies, rather than relying on cheap and plentiful labor, as some have in the past. Assuming employers can find this balance, total employee compensation should rise in line with nominal GDP growth, Yamaguchi says.

Meanwhile, Garner notes that, “the best environment for equities tends to be when nominal GDP is accelerating and the wage share of GDP is stable or declining, consistent with our forecast for 2017 and 2018." 

Japan's Annual Hours per Worker Has Declined Still Above Many OECD Countries

Source: Organisation for Economic Co-operation and Development, Morgan Stanley Research

Near-Term Winners and Losers

While modest wage inflation bodes well for the Japanese stock market on average, the sectors best positioned to benefit are those in which wages as a percentage of revenue are low, typically in the single to low-double digits. They include:

  • Real Estate: Wages represent anywhere from 0% to 10% of revenues, but rising salaries can also be a positive for rental rates and property values.
  • Insurance: Major non-life insurance companies are likely to benefit from wage reflation, as retail consumption and housing investments pick up.
  • Media: Corporate ad placement demand is likely to grow in anticipation of a rise in consumption spending.
  • Software and Services: Wage hikes leading to a rise in consumption spending would also be a positive for eCommerce earnings.

On the other hand, logistics and healthcare names are most likely to be hurt by an increase in wages, which represent between 16% and 25% of their revenues.

Understanding the Big Picture

The question now: To what extent might rising wages catalyze consumer spending? “Textbook theory dictates that a rise in wages will tend to stimulate household spending, thereby generating upward pressure on prices and, by extension, interest rates," says Koichi Sugisaki, Morgan Stanley's interest rates strategist for Japan. “Since Japanese people have suffered under deflation for a long time, they are typically very much conservative about the future economy."

From the perspective of bond-market participants: “There seems to be a hurdle to apply this positive reflation mechanism in Japan,” says Sugisaki.

Meanwhile, a combination of a weakening yen and excess savings has created trade and account surpluses. “By now, Japan has, in absolute terms, the globe's biggest net foreign-asset position," says Global Currency Strategist Hans Redeker.

An aging population, however, could help reverse this cycle. The reason: When people retire, they stop saving and begin spending by drawing down on their nest eggs; when consumption exceeds investment, prices rise.

At the same time, an uptick in retirees means that individuals and institutions will start to repatriate more funds from abroad. “In time, that drives up demand for yen," says Redeker, noting that this shift will take a while to play out. In the short term, the yen is likely to weaken against the dollar. Morgan Stanley expects the yen to weaken to around 125 to the dollar by June, 2018, compared with a recent exchange rate of 110 yen to the dollar.

For more Morgan Stanley Research on how wage growth impacts Japanese equities, ask your Morgan Stanley representative or Financial Advisor for the full report, “Macro and Micro Implications of Wage Reflation in Japan" (Apr 2, 2017). Plus, more Ideas.