The resurgence of the Japanese equity market has been underway since Prime Minister Shinzo Abe’s term began in 2012. What should investors expect from the economy and stocks going forward? Below, the portfolio management team addresses these questions and more.
1. Would you please provide an update of Prime Minister Shinzo Abe’s growth strategy involving the “Three Arrows” program?
Since being implemented in early 2013, the first two Arrows, which include massive fiscal stimulus and monetary expansion, have resulted in economic progress. According to government reports, the economy achieved 4.2% cumulative growth over the past six quarters as of March 31, 2014.
In June, Prime Minister Abe unveiled details of the third of the “Three Arrows,” which includes longer-term structural reforms. The government aims to revitalize corporate earnings, reduce the number of idle workers and make it easier for companies to conduct business. Among several details that emerged, the plan intends to promote private investment by reducing the corporate tax rate to below 30% over the next few years and by easing regulations for businesses.
These changes will likely create a more business-friendly environment. The market should also welcome these reforms, however, patience will be required, as they are multi-year initiatives. It may be difficult to evaluate the effectiveness of the third arrow over the short term, yet the government’s commitment to economic growth appears strong.
2. Japan’s economy recently recovered from its multi-year deflationary environment. What effort is the central bank making toward hitting the price stability target of 2%?
Currently, the Bank of Japan has a wait-and-see stance, although we are becoming more optimistic that the inflation target of 2% will be met in the not-too-distant future due to improving consumer sentiment. The consumer price index (CPI) seems to have stabilized, although the consumption tax increase in April temporarily increased the overall inflation figure. In April, the year-over-year gross inflation rate was 3.4%; in May, it rose slightly to 3.7%. However, the rate excluding fresh food is still hovering around 3.2% to 3.4%.
3. How have the improvements in inflation helped the Japanese consumer?
Over the past two decades, individuals accumulated a massive amount of cash totaling $8.4 trillion as of March 2014. Although consumption spending increased prior to the consumption tax increase in April, it appears that the Japanese consumer continues to hold back on certain purchases.
Yet, several positive signs point to a recovering consumer. Base salary increases in 2014 are anticipated to be the highest in 15 years. In May of this year, the jobs-to-applicant ratio climbed to a two-decade high with temporary staff wages increasing. These conditions indicate to us that the corporate sector is facing a labor shortage, and as wages continue to rise, consumer spending will likely grow as well.
This bodes well for consumer stocks. Currently, the market appears too cautious about consumer sentiment, with consumer-related stocks trading at attractive prices. For the Japan Small Cap Fund, we have recently increased our exposure to this area of the market as we believe this position has the potential to benefit from the improving consumer.
While local shoppers may not be spending, tourists from countries including China, Thailand and Malaysia spent$14 billion in 2013.Tokyo has been focused on increasing tourism in Japan, especially from Asian countries. Enticed by more duty-free stores, the easing of visa rules and a weaker yen, a record 10 million tourists visited Japan in 2013. As a result, Japan experienced the first surplus of net tourism revenue in over four decades.
4. What other trends are occurring that could bolster Japanese stocks?
There have been a few positive developments that we believe could create value for shareholders for years to come. Earlier this year, Prime Minister Abe laid out guidelines to improve corporate governance by urging companies to appoint independent directors to their boards. In addition, the government is putting together guidelines for an institutional investors’ code of conduct, which outlines how they engage with businesses.
Also, a new index, the JPX-Nikkei Index 400, was recently created to only include stocks focused on returning capital to shareholders. This has encouraged more companies to become shareholder friendly by being more cognizant about allocating capital, buying back shares and issuing dividends.
Prime Minister Abe additionally implemented structural tax and investment changes for Japanese citizens to encourage greater equity ownership. Residents can now invest up to 5 million yen (approximately $50,000) over a five-year period on a tax-free basis. Since the Nippon Individual Savings Account was made available in January 2014, the number of accounts opened has been greater than the government expected.
