Japan Election and Macro Update
As Japan considers Prime Minister Abe's successor, fiscal and monetary policy appears to be remaining stable and Japanese corporate profits are climbing back from COVID-19 impact, at least for now.
Shinzo Abe, who recently became Japan's longest serving prime minister, announced his resignation to undergo treatment for ulcerative colitis, a chronic illness that forced him to step down in 2007 from his first term as prime minister. While the process for deciding a successor for Abe is currently not clear, we believe the following can be expected in the near term:
- Fiscal and monetary policy to remain intact—Bank of Japan Governor Kuroda's terms does not expire until April 2023
- Corporate profits to continue their recovery towards pre-COVID levels
- An orderly transition of power—Abe has announced his intention to retain in power until his successor is announced it appears a majority of the expected list of potential successors are currently working within the Abe administration
- Japanese equity markets will likely not return to pre-Abenomics days
- Long-term stability is expected for Japan's equity markets, supported by currency levels, inflows of international capital and reasonable equity price valuations.
In his second term that started in late 2012, Abe led a flexible fiscal policy, structural reforms including improving corporate governance, coupled with the Bank of Japan (BOJ) shifting towards a more accommodative policy, in our view. Abe's three-pronged policy package widely referred to as “Abenomics”—aimed to have Japanese domestic economy exit out of deflation as much as possible—seems to have attracted global investors' attention to investing in Japan's equity markets.
During Abe's second tenure in office, unemployment levels were reduced by half, falling from 4.3% in December 2012 to 2.2% in December 2019 due to various factors. Over the same seven-year period, the Nikkei 225 Index rose from 10,395 yen in December 2012 to 24,120 yen in September 2018. Inflation rates, which is still far from the central bank's target, has at least kept deflation at bay.
Orderly transition of power likely, and accommodative monetary policy expected to remain intact
We expect the election of the new prime minister to be handled fairly smoothly and quickly, along with any regular, previously scheduled elections. There are multiple candidates reported to show interest, including Deputy Prime Minister Taro Aso, Chief Cabinet Secretary Yoshihide Suga, and Policy Research Council Chairman Fumio Kishida, and in our view, we assign a low probability that the future prime minister would radically change the current course of policies.
While Japan's domestic economy is still in a recessionary environment amid the outbreak of COVID-19, we expect fiscal policy will likely continue as it has been thus far and remain more accommodative than other developed countries. More importantly, monetary policy is still under the guidance of current BOJ Governor Haruhiko Kuroda, until his current term ends in April 2023.
Three reasons we believe Japanese Equity Markets will not return to pre-“Abenomics” days
While we expect a short-term shock to Japan Equity Markets in the very near term, we do not expect the resignation of Abe will send the equity markets back to the days in 2012, where high volatility and uncertainty was experienced in the Japanese equity markets, for three reasons.
- First, the currency. The exchange rate between the U.S. dollar and Japanese yen has seen a rise from sub-80 yen level in 2012 to over 120 yen in 2015. We believe the move in part was led by Abe's policies, but it was also led by the more accommodative monetary policy overseen by the BOJ's relative monetary policy stance among major central banks and U.S.-Japan bond yield spread widening, but not limited to, these reasons. Among these, all but the BOJ's monetary policy has been already suggesting a stronger yen, as the U.S. Federal Reserve and the European Central Bank, in our view, also have a more accommodative monetary policy and bond yields. We believe these have all contributed to the strengthening of the Japanese yen over the past few years, but in our view a number of factors, including the BOJ solely stopping its accommodative stance and/or the U.S. 10-year bond yields going well below its current levels will be required to continue to see improvement in the value of the Japanese yen which may be less likely in the long term.
- Second, investor flows. Foreign investors remain major buyers of Japanese equities. In 2013, foreign investors were net buyers of 15 trillion yen of Japanese equities. However, foreign investors have been net sellers of Japanese equities for the past few years since then, and year-to-date 2020 through the end of August is no exception with a net selling of nearly 8 trillion yen. In terms of flows, the majority of “Abenomics” inflow has already gone out, leaving Japan market as one of the more underweighted regions in the broader global equity context.
- Third, valuation. Despite a strong decade of Japanese equity performance, valuation levels have stayed more or less the same, and in recent years, have come down more often than not. Japanese equity performance has been driven primarily by corporate earnings growth, and less so as a result of expansion directly attributed to policies under the “Abenomics” era.
Long-term stability for Japan's markets
In our experience investors dislike uncertainty, so Abe's resignation could create some short-term volatility for Japan's equity markets. However, we believe that sentiment could stabilize quickly based on expected continuity of fiscal and monetary policy. Taking a longer-term view, we expect Japan's markets to remain fairly stable as long as key policy pillars remain in place for the most part. Many among the list of potential successors are not expected to make dramatic changes to policy based on their experience with the current administration. In addition, we see no big impact on the BOJ's monetary policy while Governor Haruhiko Kuroda remains at the helm. Kuroda's term is set to expire in April 2023.
As always, we believe an active approach to stock selection is essential for capturing long-term growth in Japan. While many companies in Japan are innovating and growing, Japan's broader market indexes have not yet caught up to this trend of innovation. Japan's growth story remains about individual companies rather than its overall economy. Growth leaders tend to be companies that have found new products and services to sell, or those that have uncovered new ways to reach customers. We believe Japan's future—grounded in innovation, automation and intellectual property—will be very different than its industrial past. In our opinion, continuity of economic policy should provide a strong foundation for continued growth opportunities among Japanese equities.