We wrote recently about Japan and the new economic initiatives of Prime Minister Abe (his arrows of economic revival).
He explained his plan as concentrating on three fundamental areas.
- Massive monetary easing by the BoJ (pumping new money into the economy in broadly the same way as the US Fed have been doing with QE)
- Massive new government spending on infrastructure and public works (Keynesian pump prime economics
- Root and branch reforms of current inefficient regulations to encourage private sector growth (deregulation to encourage a dynamic entrepreneurial culture as per the US)
The global investment community had until Abe’s election reached a state of “investor disgust” with Japan.
Their problems seemed so intractable, the returns had been so poor for so long that most had given up on them.
The new Abe plan was so radical by comparison to all that had gone before; and the initial pace of its implementation was so determined that the former disgust quickly turned to excited exuberance.
The Yen fell sharply against the dollar; the BoJ was active in the markets buying bonds and seeing this money flooded into Japanese equities from global investors. Everyone had known that Japanese assets were cheap when compared to other major markets, but a catalyst was needed to change pricing models and finally here it was in spades, game on!
The Japanese market in the first five months of 2013 went parabolic; if the yen loss was hedged the returns were over 10% per month.
Then suddenly at the end of May the market reversed with a series of huge single day losses and some epic intraday volatility; the yen strengthened against the dollar and a speech in Early June by Abe was dubbed disappointing and timid.
WHAT’S GOING ON?
The reality is that not much (if anything) has actually changed.
- This was and is a huge experiment but they have no other choice and realistically they have to go “all in” from here, doing whatever it takes to try to create growth and inflation. We are less than 12 months into the programme and to retreat now will be terminal for its international reputation and economic viability
- Although two parts of the plan have been implemented, structural reform will not start until after the upper house elections in July (Abe doesn’t want to be too specific before these elections which is why his speech lacked detail). However, changes are likely to be radical assuming they win the elections which they are expected to do, and they will have three years ‘election free’ time to implement these
- Pension funds in Japan have have not been buyers of equities; many have now indicated that they are reviewing asset allocation and this is likely to make them change their minds. This could take a few years to implement but is a significant change in market demand
- Huge amounts of hot, momentum chasing money flooded into Japanese equities in the early part of the year. Momentum investing pushes up returns excessively when positive, and creates excessive volatility and losses when it reverses. This is the reason for the recent violent declines; when the excess funds are pulled out, by definition it happens quickly and so floods the market with sell orders and insufficient buyers are available, so prices gap down to find a bid.
Japan has serious internal issues but it also has many great multinational Companies.
- A lower yen increases profits for multinational companies as foreign earnings are converted to yen at better rates and goods priced in yen become cheaper
- Inflation increases consumption internally
- Labour reforms increase entrepreneurship
- Increasing wages increases consumption
- There is a significant shift in management style within companies; younger CEOs are being installed (average age 45) replacing the old guard (average age 65) and these new CEOs have the ear of the government and BoJ governor
- Companies in Japan are extremely positive about the reforms and are using the weakened Yen to increase margin, rather than market share – so more companies are investor orientated
There will be possibly significant “unintended consequences” from the economic actions being undertaken (JGB interest rate rises for one) but fundamentally investment is the analysis of the pros and cons of “what you are asked to give in return for what you then receive” and this looks a lot more attractive now for Japanese equities than a year ago, or indeed two weeks ago!
NOTE: This is written in a personal capacity and reflects the view of the author. It does not necessarily reflect the view of LWM Consultants. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. This is not a recommendation to buy any product or service including any share or fund mentioned. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.