Corporate profit growth and additional monetary stimulus by the Bank of Japan are likely to drive further gains for Japanese stocks in 2014, according to Miles Geldard (pictured) and Lee Manzi, managers of the Jupiter Strategic Reserve Fund. Structural reform, whilst welcome, is likely to play a lesser role…
Arguably, the chief bottleneck in Japan’s economy for the past two decades has been a deflationary mindset and the aftermath of the massive credit boom of the 1980s. Since Prime Minister Shinzo Abe took the reins of power in December 2012 and fired the first “arrow” of his economic strategy – a bold policy of massive monetary easing – Japan appears to have freed itself from the shackles of endemic deflation. In December 2013, core inflation rose 1.3%, its fastest rate in five years, largely on higher imported fuel costs. Left unchecked, however, higher energy prices could have a negative impact on the economy.
Abe’s first arrow, which aims to double the money supply in two years and achieve a target inflation rate of 2%, has also sparked a 20% depreciation in the country’s currency. Prior to this, Japan’s biggest exporting companies had been struggling to compete with their foreign rivals, hampered by a US dollar-yen exchange rate stuck in a 75-85 trading range for a number of years. With depreciation, the immediate effect on exporters was dramatic and the stock market rallied.
Elsewhere, sceptics remain concerned that the April sales tax increase from 5% to 8% will squeeze households. Whilst one must be cognisant of the risk to consumption, we do not feel that the impact will be like 1997. Back then, the Hashimoto government prematurely raised the consumption tax from 3% to 5%, against the backdrop of the Asian financial crisis, a move that still has economists debating whether it plunged Japan in a deeper recession than it might otherwise have had to endure.
To encourage consumers to spend therefore the Japanese government will need to ensure consumers see more money in their pockets. Abe has been urging companies, with some success, to raise wages to mitigate the impact of the sales tax rise. Toyota’s labour union, for instance, is seeking to raise base salaries for the first time in five years. Higher wages and additional fiscal stimulus are putting the country’s economy on a more robust footing, but it could take months to see whether Japan is more robust than in 1997. The government is also preparing investment tax breaks and an accelerated depreciation scheme to encourage investment.
Despite these various measures, many investors still remain cautious, believing Japan is incapable of change. Yet the seeds of change, in our view, have been sown. If institutions can move away from an ingrained deflationary mindset and bring equity exposures to levels commensurate with a more normal inflation outlook, there could be considerable buying of Japanese stocks. Domestic demand for Japanese equities could rise too, with the introduction of Nippon Individual Savings Accounts, a shift of public pension funds from bonds to equities and additional ETF purchases by the Bank of Japan.
