A favourite Bill Murray film of mine, in which the hero is doomed to repeat the same day endlessly (although nothing matches his 'Lost in Translation' performance, which was of course set in Toyko and reflects the unique sense of alienation most foreigners experience in dealing with Japan). I wrote in April that an outbreak of bullishness by many commentators on Japanese equities was sadly misplaced (Japan: Land of the Setting Sun...). Since then we have had activist hedge fund TCI's battle against J-Power management overruled in the courts on grounds of 'national security' in a symbolic confirmation of the continued dominance of local corporate elites over shareholders, GDP growth steadily downgraded to a current estimate of 1.2% growth to end March '09, and consumer confidence slumping to a 26 year low. All this against the background of political inertia stifling any economic reform progress and impending demographic implosion.

Many have welcomed the return of inflation to Japan after a decade of corrosive deflation (1.5% in May yoy), and I would also if that inflation were generated by domestic demand conditions rather than surging import costs, particularly for commodities like oil and food. Unfortunately, like China, Japan is suffering a rapid deterioration in its terms of trade. Excluding food and energy, the CPI was actually down 0.1% yoy in May, reflecting the depressed state of domestic demand. Inflation in Japan is purely of a cost-push nature rather than demand-pull, and that is crucial from an investment standpoint. Average household spending fell 3.2% in May in real terms from a year earlier, with average monthly household income down 0.6%, the third straight month of decline, while unemployment reached 2.7m in May, up 120k yoy. Total employment fell 210k from a year earlier to 64.78 million, the largest decline since June 2004 and the fourth straight monthly drop. Despite the Nikkei having outperformed the S&P since the March lows, largely supported by hopes that Japanese banks are immune from the credit crisis (and after a relentless 18mth slide), fundamentals remain among the worst of any developed economy and I'd expect US equities to resume outperforming imminently in a bear rally.

Stagflation is already having a more depressive impact on confidence and spending that anywhere else, and that's before a slump in capital goods export demand from slowing emerging markets kicks in, as I'd expect later this year. With a debt/GDP ratio of 170% and secular growth prospects less than half those of the US based on demographic and productivity differentials, I think markets have more reason to panic about the long term creditworthiness of Yen assets than Dollar ones. Japan's inability to pull itself out of a prolonged growth funk is a warning to politicians and central bankers everywhere that aggressive and imaginative action is required to reverse a deflationary psychology taking hold across the financial system. It seems the US has absorbed that lesson, but sadly not Europe, and I know where I'd rather invest right now.