Japan at Inflection Point
The Japanese equity market staged a powerful rise in 2013 supported by a flood of good news. After a landslide victory at the end of 2012, prime minister Abe announced a series of monetary, fiscal and growth policies that were unprecedented in terms of size and speed. In particular, the new governor of The Bank of Japan (BoJ) announced a doubling of the monetary base and a target of 2% inflation in two years’ time. This sent a clear message that this time, the government and the BoJ were serious about reversing the yen’s strength and deflation, the two major causes for nearly 20 years of stagnation. Helped by the fiscal stimulus and a weaker yen, the effort to kick start the economy worked well in year one, boosting the expected earnings of TOPIX listed companies to about 30% for the fiscal year ending March 2014.1
Is the good news already priced in?
No. Despite the significant positive turnaround in the political and economic backdrop with company earnings and the stock market both rising, global investors are still underweight Japanese equities and we expect them to shift out of this position.
Another factor supporting the market is that Japan has yet to experience the rebound seen in global equity markets that occurred in tandem with an earnings recovery following the financial crisis. The 2011 earthquake, the strong yen and rotating prime ministers have held back Japan’s recovery. Even after the stock market rise in 2013, the Japanese equity market has not caught up with the earnings recovery seen in other equity markets since 2008; and it has yet to factor in the potential for change.
For 2014, the corporate earnings outlook is again encouraging. Prime minister Abe is expected to continue to push hard with the changes necessary to get Japan back on a longer-term growth path. He is also expected to continue his “flexible fiscal policy” to ensure that the momentum in the economic recovery is maintained when he carries out tax reform in the second quarter. The weaker yen is also supportive. Sceptics say the current strength in the economy is a temporary phenomenon supported by fiscal spending and the rush to buy before the consumption tax rises from 5% to 8% in April 2014.
There are signs this view may be too pessimistic. We have started to see improvement in the real estate sector, a rise in property prices and a marked decline in the central Tokyo vacancy rates, which signals an improvement in confidence for a period longer than a few months. According to a survey conducted by the ministry of health labour and welfare, about 80% of businesses say they plan to increase pay in 2014.2
The long-term attraction
The most attractive aspect of the Japanese market is the prospect for a sustained, longer term recovery. Japan’s nominal GDP (a more appropriate measure for a country suffering from deflation than real GDP), peaked in 1997 and had been declining until 2012. In this environment, companies curtailed capital expenditure and spending of all kinds including investing in people. This is evident from how manufacturing facilities aged from about 10 years in the late 80s to over 15 years in 2012.3
It is also reflected in the increase in the proportion of part-time workers from about 18% in 1995 to about 35% in 2011.4 As a result, the loan to deposit ratio of the banking industry has fallen from over 100% in 1995 to only 60% in 2013, reflecting a vicious cycle of deflation and negative business sentiment.5
Once deflation ends, we believe the investment opportunities for the Japanese market are attractive on an extended time horizon and we believe prime minister Abe is on track to accomplish this. Last but not least, the Abe administration continues to command high support from the public despite the introduction of some unpopular measures.6 These include the increase in consumption tax, inheritance tax, and medical burden on the elderly. This time the public is signalling it is willing to swallow bitter medicine for the sake of its economic future. The country appears to be ready for a real change.
- Still unloved and under-owned, Japanese equities have yet to catch up with earnings recovery
- Improvement in the real estate sector signals a rise in confidence about the future
- Once deflation ends, the long term investment opportunities are likely to be attractive
1. Source: Nikkei Newspaper, 3 November 2013.
2. Source: Nikkei, 30 June 2013.
3. Source: Nomura, December 2013.
4. Source: Ministry of Health Labour and Welfare, 2011.
5. Bank of Japan, October 2013.
6. Source: Joint survey conducted by the Nikkei and TV Tokyo, 24 November 2013.