Since his return to power late last year in a landslide election, Prime Minister Shinzo Abe of the Liberal Democratic Party (LDP) and his advisers have unleashed a bold set of macroeconomic reforms designed to revive an economy that has lain dormant for almost two decades. The Bank of Japan (BoJ) has also joined in the effort; the new governor, Haruhiko Kuroda, announced an aggressive easing policy in April 2013 and raised the central bank’s inflation target to 2%, pledging to double Japan’s monetary base through buying long term bonds amongst other assets.
While the renewed confidence in the government and their policies drew investors in, an understandable pause followed. Some form of a correction in the Japanese equity markets was expected given the rapid rise in prices, a reversal in yen weakness and the possible change in the US Federal Reserve’s (Fed) approach to monetary stimulus announced in May.
Thus a period of consolidation began over the summer months as some foreign investors who had rushed in with overly high expectations withdrew, while the Japanese markets took a back seat to the better news coming from Europe and its periphery.
Second, the economy has begun to show signs of a solid recovery. Japan’s gross domestic product (GDP) growth rose at an annualised 4.1% in Q1, driven in large part by strong consumer spending. In Q2, GDP rose at a much faster than expected 3.8%, helped by a marked improvement in capital expenditure. This was the third straight quarter of growth for the country. Reinforcing this the new deflation busting measures are working, the core-core consumer price index (a closely watched measure of Japanese deflation) stopped worsening for the first time in five years in September, while the official inflation rate reached 0.7% in the same month, recording the fourth consecutive month of increases. Additionally, recent Tankan surveys (the closely watched BoJ report) have revealed a sharp improvement in sentiment among Japanese manufacturers.
The outlook for Japan remains positive and there are a number of factors to draw comfort from over the next couple of years. The effects of Abe-san’s policies and the dramatic easing by the BoJ are yet to fully flow through the economy. The changes that are underway are of such magnitude that the positive impact on the economy could last many years.
Given our strong belief that capital expenditure will increase and wages are on the rise, the bias of our portfolios remains to the domestic economy. We are overweight financials and domestic discretionary names, and by default, are light of overseas facing industrials and areas of the stock market that we consider expensive.
The profit outlook in Japan remains solid, perhaps even better than elsewhere in the developed world. Japan’s markets have fared well over the past 12 months and whilst a period of consolidation over the summer months might have proven frustrating, investors should not lose faith at this juncture as we believe that Japan’s road to recovery is only part-travelled.