Japan Market Memo: Abenomics' shine fades as consumption tax looms

03-28-2014

It would be tough enough if next week’s jump in Japan’s consumption tax from 5% to 8% is all Japanese Prime Minister Shinzo Abe had to worry about. But the collective reforms known as “Abenomics” launched following his late 2012 election—helping propel Japan’s economy out of the gate in 2013 and Japanese equities to their biggest annual gain in 42 years—are exhibiting signs of fatigue.

Japan’s GDP rose at only a 0.7% annual rate in last year’s final quarter, down from a 4% pace in 2013’s first half, and the Nikkei is down 10% year-to-date after rising 57% last year. Factory output, core inflation and retail sales have been rising, but some of that likely reflects the “pull-forward’’ effects of households making big-ticket purchases such as homes, cars and appliances ahead of next week’s tax hike. Indeed, many are projecting the world’s third-largest economy to contract in the spring as consumers pare purchases when the first increase in consumption taxes in 17 years kicks in on April 1.

Some of this leveling off is to be expected. Many of the initial steps Abe took—extremely aggressive monetary easing in conjunction with the Bank of Japan and massive increases in government spending, the first two arrows of his so-called “three-arrow’’ strategy to pull Japan out of a two-decades-long deflationary funk—were the easiest to achieve and the quickest to show early results.

Now comes the hard part
But the third arrow—somewhat still ill-defined reforms aimed at growing the labor pool, restructuring corporate taxes , improving corporate competitiveness and boosting wages,  among other things—is still largely stuck in the quiver and likely will prove the hardest to put into flight. For example, during my recent visit to Japan, some corporations such as Toyota and Honda said they were willing to boost wages to help offset the impact of higher taxes, but others such as Suzuki weren’t. And even those raising pay were talking about increases in the 0.5-to-1% range—we’re talking about $26 a month, not a lot of extra spending power! In fact, these token wage increases are less than enough to offset the consumption tax hike. As a result, a worker’s real compensation actually will decrease.

Adding to these domestic difficulties is a slowing China, which had usurped the U.S. as Japan’s largest trading partner since 2009 until last year, when the U.S. reclaimed the position. Japan needs the economies of the U.S. (18.8% of Japanese exports) and China (18.1% of Japanese exports) to be strong to continue pulling its economy along. Last year’s weaker yen also helped exporters and gave a lift to Japanese stocks and earnings, but year-to-date the yen has been relatively range-bound. In discussing Japan’s stalled equity market, others highlight the political missteps by Abe himself. A fervent nationalist, Abe has fostered worries about militarism at home and abroad because of his desire to reform the constitution to expand Japan’s military and because of a December visit the Yasukuni Shrine, a controversial memorial because it includes convicted war criminals alongside Japan’s war dead.

None of this is to suggest that Abenomics is a failure or that Japan isn’t an improving long-term story for investors, only that the easy work has been done. Might the Nikkei rebound in this year’s second half? Yes, particularly if Japan’s economy picks up some momentum and the third arrow begins to fly. Relentless monetary stimulus also should help, as the Bank of Japan is expected to step up purchases of government debt even further. But the message for investors is to exercise caution, i.e., pick your spots; a lot of hard policy work is still to come.

Leonardo A. Vila
Leonardo A. Vila
Senior Portfolio Manager


 
 
 
 
 
 
 
 
 
 
 
Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.
Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.
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