Since Abenomics began two years ago, we’ve seen some improvements in the Japanese economy. What should investors expect in 2015? In the discussion below, the portfolio management team of the Hennessy Japan Fund (Trades, Portfolio) and Hennessy Small Cap Japan Fund addresses Japan’s current economy and its impact on the market.
1. Would you please summarize the economic progress following Prime Minister Shinzo Abe’s push for growth?
After taking office at the end of 2012, Prime Minister Abe implemented a series of concerted reforms that became known as “Abenomics” in an effort to revive the Japanese economy. Abe’s “Three Arrows,” include massive stimulus, monetary expansion and long-term structural reforms.
The stimulus programs and monetary easing were launched first and their impact was quickly felt. For example, signs of inflation and a weaker yen boosted employer confidence and resulted in the jobs-to-applicants ratio hitting its highest level in 22 years and the unemployment rate approached a 16-year low. By the end of 2014, the third arrow, or structural reforms, began to make an impact as well. This initiative, focused on creating a more business-friendly environment, included reducing the corporate tax rate from 38% to 35.6%, improving corporate governance, and increasing return on capital for shareholders. In addition, the JPX-Nikkei Index 400 was launched. This Index includes only those companies focused on returning capital to shareholders, which has encouraged more companies to be more cognizant about allocating capital, buying back shares and issuing dividends. As a result, equity ownership in Japan is on the rise.
2. Following the first round of the consumption tax increase, quarterly GDP growth was muted and the second tax hike was delayed until April 2017. How has this action affected sentiment in Japan?
The sales tax hike took effect at a crucial point when Japan needed to sustain its positive trend. However, the tax increase appeared to negatively affect consumers more than expected. Some progress has been made in employment conditions, with the monthly worker salary increasing 0.5% compared to the previous year, but real wage growth remains under pressure. While inflation is improving, core CPI remains below the Bank of Japan’s target of 2%. Given the strain on the consumer, Prime Minister Abe delayed the second round of the consumption tax increase until April 2017.
Concurrently, the Bank of Japan substantially increased monetary stimulus by announcing that they would purchase 80 trillion yen in government securities per year, the equivalent of approximately $650 billion, which is an increase of 10-20 trillion yen over its current policy. We are encouraged by the government’s proactive response, as it demonstrates policymakers’ strong commitment to economic growth.
3. As the yen continues to weaken relative to the U.S. dollar, what has been the net effect on the Japanese economy?
We believe the weaker currency compared to the U.S. dollar has been net positive for Japan’s overall economy because Japan’s largest domestic companies have a significant overseas presence. A weaker yen benefits exporters, making Japanese products more competitive globally and increases profit levels when foreign currency is converted back into yen. We also see a weaker yen indirectly benefiting smaller and more domestic focused companies in Japan.
We anticipate that export-oriented companies will create a positive economic growth cycle of boosting capital investment, thereby bringing manufacturing back to Japan. This may lead to hiring more workers and higher wages, which could result in increased consumption.
Domestic consumption is an important driver of Japan’s economic growth as Japan is not largely dependent on global trade. Exports comprise only 11% of GDP. The country has a large consumption base with a population of 127 million; therefore, as business sentiment improves and capital expenditures rise, we believe a domestic demand recovery should become evident over the next year.
4. What additional drivers could boost Japanese equities in 2015?
In addition to domestic demand potentially boosting equities, we believe there are two notable drivers. First, to encourage greater equity ownership, investment changes were implemented for Japanese citizens. Under the Nippon Individual Savings Accounts program, or NISA, Japanese residents can invest up to 5 million yen (approximately $50,000) over a five-year period on a tax-free basis. Since its introduction in January 2014, NISA has grown to 7.3 million accounts with $16 billion invested as of the end of June 2014.
Secondly, Japan’s Government Pension Investment Fund (GPIF), the world’s largest pension fund, is also expected to spur higher Japanese equity ownership levels. In late October 2014, the GPIF, which holds $1.2 trillion in assets, adjusted its asset mix to increase its exposure to Japanese stocks from 12% to 25%. We anticipate other Japanese public and private pension funds to follow the GPIF’s lead.
Important Disclosures Investors should consider the investment objectives, risks, charges and expenses carefully before investing. This and other important information can be found in the Fund’s summary and statutory prospectuses, which can be obtained by calling 800-890-7118 or visiting hennessyfunds.com. Please read the prospectus carefully before investing. Mutual fund investing involves risk; Principal loss is possible. Small and medium-capitalization companies tend to have limited liquidity and greater price volatility than large-capitalization companies. Investments in foreign securities involve greater volatility and political, economic and currency risk and differences in accounting methods. The Fund may participate in initial public offerings (“IPOs”) which may result in a magnified impact on the performance of the Fund. IPOs are frequently volatile in price and may increase the turnover of the Fund, which may lead to increased expenses.
Each Morningstar category average represents a universe of funds with similar objectives. The Russell/Nomura Total Market Index is a market capitalization-weighted index of Japanese equities. The Tokyo Stock Price Index (TOPIX) is a market capitalization-weighted index of all companies listed on the First Section of the Tokyo Stock Exchange. The Russell/Nomura Total Market Index and TOPIX indices are presented in U.S. Dollar terms. JPX-Nikkei Index 400 is composed of 400 companies with high appeal for investors, which meet requirements of global investment standards, such as efficient use of capital and investor-focused management perspectives. The index was jointly developed by Nikkei, Japan Exchange Group and Tokyo Stock Exchange. One cannot invest directly in an index.
Morningstar Proprietary Ratings reflect risk-adjusted performance as of 12/31/14. For each fund with at least a three year history, Morningstar calculates a Morningstar Rating™ based on a Morningstar risk-adjusted return measure that accounts for variation in a fund’s monthly performance placing more emphasis on downward variations and rewarding consistent performance. The top 10% of funds in each category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars and the bottom 10% receive 1 star. Each share class is counted as a fraction of one fund within this scale and rated separately, which may cause slight variations in distribution percentage. HJPIX received 4 stars for the three and five year periods and 5 stars for the ten year period ended 12/31/14 among 22, 15 and 8 Japan Stock Funds, respectively. HJPSX received 5 stars for the three and five year periods ended 12/31/14 among 22 and 15 Japan Stock Funds, respectively. Ratings for other share classes may differ. ©Morningstar, Inc. All Rights Reserved. Past performance does not guarantee future results.
Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by consumers for a market basket of goods and services.
