In the following commentary, the Portfolio Management team of the Hennessy Japan Fund (Trades, Portfolio) and Hennessy Japan Small Cap Fund (Trades, Portfolio) provide their perspective on the Japanese economy, recent initiatives taken by the government to encourage growth, and a rise in merger and acquisition activity.
1. Prime Minister Shinzo Abe ordered a new round of fiscal stimulus spending after his recent reelection victory. Would you please comment on the market’s reaction to the proposed stimulus?
Underscoring his commitment to long-term economic growth, Prime Minister Abe announced a fiscal stimulus package of approximately $265 billion at the end of July 2016. Additionally, the Bank of Japan announced plans to double the size of its exchange traded fund purchases and expand the U.S. dollar lending program to help companies access foreign funding and invest abroad.
While some analysts may have expected more, we see the recent actions as short-term measures to prevent Japan from falling into a recession. We believe the government may make more significant changes as part of the supplementary budget package expected to be announced in September.
2. What additional actions has Abe taken to stimulate the economy?
Abe has recently unveiled Abenomics 2.0, a revised three-prong plan focused on the government’s continual structural reform efforts. Whereas Abe’s original plan, Abenomics, concentrated on fiscal stimulus, monetary easing and structural reforms, these revised “arrows” are focused on broader structual issues that are challenging growth.
Abe’s three new policy “arrows” include:
1. A nominal GDP target of 600 trillion yen (approximately $6 trillion). To accomplish this target, the government has been promoting reforms that could transform and escalate growth, such as driving the use of big data, artificial intelligence and robots as well as expanding the healthcare and medical services industry.
2. A focus on increasing the birth rate to 1.8 births per woman. An increase from Japan’s current birth rate of approximately 1.4 should help to stabilize the country’s aging population. Abe has implemented plans to provide easier access to childcare to encourage women to return to work.
3. A plan to improve senior services. The government has implemented improvements in nursing facilities for the elderly, which may reduce the number of people leaving their jobs to care for ailing family members.
We believe investors should focus on the revised Abenomics 2.0 as the plan reflects the “big picture” structural reforms aimed at improving growth over the long term.
3. Would you please discuss additional structural reforms that might have a positive effect on the economy?
We believe that no one policy can improve the economy; rather, all the structural initiatives in aggregate are needed to make a meaningful impact. We are confident that several reforms, collectively, will likely improve the economy due to the fact that the government and the Bank of Japan have become more business friendly in the pursuit of sustainable long-term growth.
These measures have included a gradual reduction in the corporate tax rate from above 38% to below 30% over multiple years as well as initiatives to improve corporate governance and increased labor force participation by women and retirees.
Labor market reform has become a key initiative, with Prime Minister Abe promoting “equal pay for equal work” in an effort to boost consumer consumption. Currently, part-time and temporary contract employees make up approximately 40% of the total workforce and many of these workers are underpaid. Abe has sought to improve Japan’s low productivity and labor inequality by encouraging companies to pay the same wage for workers doing the same job and reduce the pay differential between part-time and full-time workers.
We encourage investors to remain focused on this collective group of structural reforms as we acknowledge that these initiatives will take time for results to materialize, requiring patience and a longer time horizon.
4. What has propelled the increased level of merger and acquisition (M&A) activity abroad by Japanese companies?
M&A activity has increased as companies conform to the recently implemented corporate governance code and engage in shareholder friendly practices, such as increased return on equity. In addition, interest rates have been historically low, which allow companies to leverage their balance sheet with a manageable level of debt payments.
Notable examples of Japanese companies seeking growth abroad include the following all-cash acquisitions that were the largest transactions for each respective firm:
»» Japanese mobile phone company, SoftBank Group Corp., announced its purchase of ARM Holdings, a British multinational semiconductor and software design company, for more than $32 billion, which was at a 40% premium to ARM’s stock price on the day of the announcement.
»» Precision motor manufacturer Nidec Corp. acquired Emerson Electric’s motors, drives and electric power generation business for $1.2 billion.
Key Points to Emphasize about Japan’s Economy
- We believe the recent fiscal stimulus was a one-time, short-term measure to prevent Japan from falling into a recession.
- The revised Abenomics 2.0 highlights the “big picture” structural reforms aimed at improving long-term growth.
- Labor market reform has become a key initiative, as Abe promotes “equal pay for equal work” in an effort to boost consumer consumption.
Fund holdings and sector allocations are subject to change at any time and are not recommendations to buy or sell any security.
Start a free 7-day trial of Premium Membership to GuruFocus.
