To be sure, Abenomics – prime minister Shinzo Abe’s package of policies to revitalise the Japanese economy – still has its doubters. That’s understandable, no one ever said curing Japan’s two decades-old malaise would be easy. But it’s also a good thing – it means Japan can still enjoy capital inflows if the experiment continues to work.
The recent move by the Bank of Japan (BoJ), to intensify its monetary medicine, and by the Japanese Government Pension Investment Fund (the world’s largest institutional investor) to radically increase its allocation to Japanese stocks are important steps along the road.
We had significantly built our holdings in Japan in the Neptune Global Equity and Neptune Global Alpha funds in anticipation of these moves, and it has proved rewarding. We believe though there is much more to come, and the move we saw following these announcements was just one step along the way. Our view is that Japan has no choice but to continue the reforms it has started, and these reforms are still in the early stages.
For instance, if you believe the BoJ has grown its balance sheet so far, you ain’t seen nothing yet. It has now publicly drawn parallels with the Bank of England’s 40 per cent holding in gilts when compared to its own 20 per cent holding in Japanese government bonds and would clearly go even further than that.
The impact of the reforms and policy changes on underlying asset prices is not yet anywhere near reflected in current stock prices. We believe we are very early on in a multi-year bull market in Japan.
Performance of index over 2yrs
Source: FE Analytics
The next challenge prime minister Abe faces is to decide on the timing of the remaining part of the planned hike in consumption tax from 8 per cent to 10 per cent, having raised it from 5 per cent to 8 per cent this April.
It is legislatively scheduled for October 2015, but that might not be good timing for the economy. A fiscal tightening like this would work perhaps too aggressively against efforts to raise inflation to the 2 per cent target. The BoJ hopes to embed ongoing inflation expectations at this level in order to put the deflation years to bed.
This certainly appears to be the lesson from the experience of April’s consumption tax hike, given that core CPI has fallen back from 1.5 per cent in April to 1 per cent today. Better to go slower on consumption tax and get both jobs done in sequence, the inflation turnaround being the most pressing. This is so long as you don’t believe that a government bond market crisis is around the corner – which you shouldn’t.
That might be good economics but is it good politics? Well therein lies the rub. The public would certainly be happy to go slow but Abe has promised the tax hike as scheduled to the Ministry of Finance. It would publically embarrass key officials there were he to postpone it. He will work hard to avoid this as he works to bring the Japanese political class with him on the journey.
However, he has two options to square the circle. The first is to implement a supplementary budget in the form of tax benefit handouts, which would in particular support lower income consumers as the consumption tax hike hits. This would neutralise the fiscal impact on the economy in 2015, or at least smooth it over 2015 and 2016.
The second option is more radical but has risen in probability during the past week. This would be to call a snap election to be held before the end of the year, in order to get a public mandate to postpone the tax hike – thereby allowing the Ministry of Finance to save face. It would also serve as a timely act of political renewal for Abe, given the current weakness of his opponents.
A positive stock market is an important mechanism of the effect of Abenomics on the economy, so it’s not surprising that Abe has had the idea of a snap election officially leaked to gauge market reaction.
The market appears to like it – as we write it is up over 2 per cent since the leak – and we do too. A snap election tends to be a sign of strength. It certainly was for Mr Koizumi in 2005, immediately after which both his popularity and the stock market surged – and we believe it would be for Abe.
The broader point, however, is that economic imperatives have embedded themselves into the Japanese political system and we believe that investors will be rewarded for aligning themselves accordingly.
Robin Geffen is chief executive of Neptune Investment Management and James Dowey is the asset management house’s chief economist. The views expressed above are their own.
