Market Memo: Can Japan change from deflation to inflation?
We are beginning to see the green shoots of growth in Japan. Tentative signs of improvement can be seen in April’s job listings at major Japanese recruiting agencies, which are up significantly to their highest level since 2006. Japan’s Nikkei newspaper reports that the number of listings at JAC Recruitment jumped 61% year-over-year, with notable increases in construction and real estate. Moreover, Japan’s jobless rate fell in March to 4.1%, its lowest in four years, while first-quarter GDP rose a better-than-expected 3.5% on rising exports and consumer spending.
As we’ve noted before, since the Liberal Democratic Party’s return to power in December, Prime Minister Shinzo Abe has acted aggressively to revitalize Japanese growth. The latest component is his so-called “Growth Strategy,’’ which isn’t expected to be fully unveiled until late June. It’s anticipated the broad plan for economic revitalization will include creation of three new business councils directing economic and fiscal policy, industrial competitiveness and regulatory reforms.
Collectively, this strategy will represent the “Third Arrow” of Japan’s makeover under “Abenomics,’’ the other two being massive quantitative easing undertaken by the Bank of Japan that includes purchases not only of government bonds but also such risk-on assets as publicly held REITS, as well as equally substantial wave of government infrastructure spending. Not surprisingly, the carry trade has been abandoning the low-return Japanese yen in droves following the implementation of QE, pushing the yen/dollar exchange rate 100 for the first time in more than four years. This yen depreciation—and all signs suggest the appetite for further yen softness is growing—should help boost inflation and will certainly benefit growth among Japanese exporter corporations.
Whatever it takes
It helps, of course, that Abe is popular and ran on a pledge to do whatever it takes to pull his country out of a two-decades-long funk. The support for his Cabinet also stands at a 12-year high of 76%, providing a strong public mandate for his government to execute further meaningful structural reforms that address key areas such as labor and agriculture.
We anticipate other pieces of Abe’s new strategy will target free-trade agreements, special economic zones (tokku), tax revisions, and health care, the latter with a goal of boosting medical equipment firms and promoting next-stage research such as regenerative medicine. Abe also wants to expand Japanese tourism and may consider easing visa restrictions and making English proficiency an educational priority. The occupancy rate at major Tokyo hotels already has jumped to 87%, a seven-year high, as a weaker yen and increased growth is helping lure more tourists and business travel.
Abenomics isn’t without risk. A devalued yen is also driving up the costs of imports, which is significant given its reliance on energy sources outside of its country. But as confidence in Abenomics grows, we would expect Japan’s market capitalization to top pre-Lehman crisis levels as the initial signs of a recovery start to emerge. Even though benchmark TOPIX index has appreciated more than 60% since November 2012, we expect a further rally through the remainder of 2013 and have been raising our allocations to Japan on Abenomics’ coordinated moves and on Japanese earnings momentum, which is the strongest of the 40 countries we monitor.