Market Memo: Japan has been found
Japan’s economy has been one of extremes. The Japanese stock market is up 31.5% this year through July 31, 2013. Investors have found Japan once again after two lost decades.
Until 2013, most investors avoided the Land of the Rising Sun as it suffered through the lost decades or more than 20 years of crippling deflation. It was in a death spiral. Japanese consumers kept their wallets closed because they knew the car, washing machine or sweater they wanted to purchase would cost less the following week than it did at that moment. Consumer spending was not supporting the economy. Japanese companies seemed to have lost their edge in consumer electronics and automobiles as Walkmans were replaced with iPods and as stylish, well-built Korean cars caught the fancy of global car buyers. Japanese companies lacked signs of earnings growth, but traded on cheap multiples. The companies were never given the credit for their valuation or the cash stockpiles they had accumulated. Investors deemed Japan a value trap. The spiraling economy was reflected in the country’s politics, as failed economic policies led to a revolving door of leadership with 16 prime ministers leading the country since 1993.
With the change in the country’s leadership in 2012, Prime Minister Shinzo Abe came out with his bow and arrows—three arrows to be exact—announcing plans for the economic revival for Japan’s economy.
- The first arrow—monetary easing—hit the bull’s eye. As the newly elected chief executive of Japan, Abe installed his man, Haruhiko Kuroda, to head the central bank. The Bank of Japan launched unprecedented and aggressive policy of monetary easing combined with the target of getting inflation up to 2% within two years. This action weakened the yen and, at a minimum halted, the deflationary spiral.
- The second arrow—fiscal stimulus—is driven by government spending on public works and fiscal consolidation. Public investment, as reported at a cabinet ministers meeting in July, has solidly progressed with contracts signed in June increasing 21% over the previous year. One of the aims of this arrow is to boost job creation in local regions through public works projects. Job creation leads to consumer spending. Fiscal consolidation’s aim is to cut debt-to-GDP in half by fiscal year 2015.
- The third arrow—structural reform—is full of initiatives to achieve growth through private investments and to make Japanese industry and institutions more competitive.
While there is much to do, the immediate targeted areas are: increasing the labor pool, balancing energy and the environment, and tackling health and medicine. Regulatory reform is required and will be a test of political leadership and will. Interestingly, for the first time, the Diet (parliament), prime minister and central bank are all aiming toward the same goals.
Abe’s first arrow seems to have provided a remedy to what had ailed Japan, as the country is one of the best-performing markets year-to-date. Stock prices have rallied, especially for export-sensitive stocks, as the yen has depreciated 12.8% through the same period and boosted exports. Consumer spending is beginning to pick up as inflation appears. Year-over-year evidence of increased consumer spending is evident. A long awaited Upper House election in July has passed with no surprises and Abe’s Liberal Democratic Party firmly controls the congress with a coalition partner. Now with total political control, legislation is ready for easy passage. So far, so good.
Has the Japanese stock market begun to roll over? Abe’s third arrow—growth—some will argue, is still in flight. There are few details and little concreteness to the structural-reform proposals that many see as necessary for Japan’s continued success for the next several years. Lack of additional information or visible progress since June has left investors questioning the credibility of the effort. Another failed government effort will be viewed as a big disappointment and another head fake baiting investors. Part of the reason investors have seen Japan as a value trap in the past comes from the 16 prime ministers’ many failed attempts to guide the government toward concrete reform and economic growth. In fact, planned structural reform didn’t really fail, it just never materialized. Lacking any positive government initiatives, the market is likely to drift or wander aimlessly (wandering aimlessly with an arrow in flight doesn’t sound too safe) until…
Answers in late September?
The new government budget will be announced in late September or early October. At that time, the government should also announce its decision about the impending value-added tax hike planned for April 2014, which has recently come under attack. The additional tax would be a great source of revenue for the government. On the other hand, a tax increase could squash any growth efforts by flaming out consumer spending. And therein lies the potential for new problems with having so much control—division within. Abe-san has been a great cheerleader and the stock market loves him. Japan needs him to succeed this time. He, no, the entire government of Japan, can’t afford to allow an arrow to miss the target and repeat the history we’ve known for the past 20 years. Don’t rule out Abe saying the right thing, even if just to keep the market up and the people feeling good and spending. And in case you weren’t aware, Tokyo is a contender to host the 2020 Summer Olympics with the decision set for Sept. 7, 2013. The other two candidates are Istanbul and Madrid. Where would you put your money?