Japan as Number One: Lessons for America, scholar Ezra Vogel’s bestselling book that appeared in 1979, may seem anachronistic now, but global investors should not dismiss the possibility that “Abenomics” will lead to a gradual restructuring of the Japanese economy and a transformation as profound as the Reagan and Thatcher revolutions. Such a development could lead to a sustained rally in Japanese equities, but it is too soon to know whether Abenomics will deliver on its promise.
In 2013, Japan’s output growth (2.2%) is expected to exceed that of the U.S. (1.9%), and consensus holds that Japan, which has had three recessions in the past four years, will grow 1.8% in 2014. The Tokyo Stock Price Index (TOPIX), which has risen roughly 28% in yen in the first six months of 2013, still languishes at 60% below its 1989 high. Investors should maintain a strategic allocation to Japan, bearing in mind that the structural reforms needed to increase Japanese potential growth and that increased return on equity will take time to implement.
Japan has had seven prime ministers since 2006. But Prime Minister Shinzō Abe’s popularity rating is close to 70%, and he has just secured a victory in the recent July 21 upper house elections, giving the Liberal Democratic Party and its coalition partner a broad mandate to govern until 2016. Abenomics aims to spur growth and end deflation, with an explicit inflation target of 2% within two years. Its three “arrows” are aggressive monetary policy easing, fiscal stimulus and structural reform.
In the first six months of 2013, the yen fell 12% against the U.S. dollar. Japanese exporters’ profits are very sensitive to the level of the yen, and consensus holds that the yen will further weaken in the next 12 months. Newly appointed Bank of Japan Governor Haruhiko Kuroda has initiated a quantitative easing program that, as a percentage of GDP, is potentially much larger than the U.S. program.
The Abe administration enacted a fiscal stimulus program of roughly 2.2% of GDP earlier this year, and recent business and consumer surveys show increasing confidence. Domestic demand is accelerating. Abe has also promised to achieve budget surpluses by fiscal year 2020.
In terms of structural reforms, the agenda is large, including sharply increasing the female labour force participation rate and rationalizing agricultural production. The growth strategy released in June disappointed the market, but major initiatives are forthcoming. These will likely include Japan’s participation in the Trans-Pacific Partnership, tax incentives and new leasing programs, special zones to attract foreign direct investment power sector reform, and support for nuclear reactor restarts. As in Europe, labour market reform is more sensitive but a key component of higher output potential. Japan’s population is expected to shrink 30% by 2055—a powerful headwind to ending deflation. Consensus now holds that Japanese inflation will hit 2% in 2014. Abenomics is a step in the right direction, but the pace of structural reforms is key. With a 12-month forward price/earnings ratio of roughly 14.5, the Japanese equity market looks reasonably priced and holds the potential for upside surprise. Stronger growth in Japan is good news for global investors, but it will be a wait to see if Abenomics is durable.
George R. Hoguet is a global investment strategist with State Street Global Advisors. george_hoguet@ssga.com
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