The centrepiece of Abenomics lies in the three “policy arrows” of aggressive monetary policy, flexible fiscal policy and structural reforms.
While critics point to muted wage growth and low inflation as evidence that Abenomics has failed to produce the intended result, such a simple diagnosis ignores how much has been achieved.
Over the past five years, the Japanese economy has improved significantly and unemployment has fallen to the lowest level since 1994 amidst increased participation among women and seniors.
Corporate profits are at record highs and governance reforms have helped to enhance capital efficiency and boost shareholder returns, again to record levels. Against this backdrop, equity prices have more than doubled under Abe’s watch.
Certainly, some policies have scored greater successes than others (progress in labour reform and deregulation, for example, has been limited to date), but the Abenomics policy programme remains a work in progress. With prime minister Abe’s landslide victory in the recent Lower House elections marking a continuation of Abenomics, we can expect to see further incremental changes for the better.
Meanwhile, the Japanese economy is experiencing its longest period of growth in more than a decade; the policy mix remains loose, corporate profits are at record highs and companies are increasing their capital spending. Given this environment and the undemanding valuations in Japan, we believe there are attractive investment opportunities in the equity market.
Reform measures contributing to sustained economic growth
Source: Cabinet Office and Japan National Tourist Organisation
Japan is enjoying a sustained economic expansion, with nominal GDP setting a new high for the first time since the 1990s.
A synchronised global recovery and monetary/fiscal stimulus have underpinned Japan’s recent economic revival, but structural reforms in areas such as employment, corporate taxes and inbound tourism have also played a key role.
For example, the number of inbound tourists has increased dramatically under Abenomics (24 million inbound visitors in 2016 versus 8 million in 2012) and spending by overseas visitors reached a record high of ¥1.2trn in the third quarter (Jul-September 2017).
Moreover, the Japanese economy is on course to achieve growth of around 1.6 per cent in calendar 2017, exceeding the potential growth rate of 0.8% for a third straight year.
Aggressive monetary policy
Source 1: Bank of Japan
Source 2: Ministry of Internal Affairs & Communications
In the initial stages of Abenomics, the Bank of Japan (BoJ) launched its unprecedented quantitative and qualitative easing (QQE) programme under new governor, Haruhiko Kuroda.
Its large-scale asset purchases led to a sharp correction in the yen, which in turn fuelled increases in corporate earnings and asset prices. This helped to buoy the real economy and push inflation into positive territory.
However, plunging commodity prices and a downturn in emerging economies, combined with the 2014 VAT hike in Japan, generated significant headwinds. As inflation started to weaken, the BoJ increased its asset purchases and later adopted a negative interest rate policy. The existing policy framework - QQE with yield curve control - was implemented in September 2016.
Although the BoJ’s 2 per cent price stability target remains out of reach and subject to changes in macro factors, increasingly tight labour markets and diminishing slack in the economy are supportive of a gradual upturn in prices.
Indeed, the four indicators that the government uses to monitor Japan’s exit from deflation (CPI, GDP deflator, output gap and unit labour costs) produced positive readings simultaneously for the first time in 25 years in the most recent quarter (July-September). Importantly, there are also signs that the deflationary mind-set, which has beset the country for many years, is shifting, and companies are starting to raise prices.”
Flexible approach to fiscal policy
Source 1: Ministry of Finance and Cabinet Office
Source 2: Ministry of Finance
While prime minister Abe has postponed the objective of reaching a primary fiscal balance by 2020, the country’s fiscal situation has improved due to measures such as the 2014 sales tax hike to 8 per cent and sustained increases in tax receipts.
Japan’s relatively stable economic conditions and easy monetary policy have also helped to control the deficit and keep debt funding costs low. A more flexible approach to fiscal stimulus under Abenomics should enable the government to implement policies (for example, the enhancement of social security and education, public infrastructure and further structural reforms) that are conducive to future growth.”
Strong growth in employment
Source: Ministry of Internal Affairs and Communications
Labour participation rates among women and seniors over 65 have risen sharply since 2013 when ‘Abenomics’ was first set in motion (Japanese female labour participation has surpassed the US for the first time in history, according to data from the OECD).
Policy measures such as increasing day-care facilities for children, labour reforms, and the promotion of more flexible work styles are helpful. The inflow of guest workers on student/work experience visas has steadily increased as well.
The number of people in employment is now close to a record high of 65.8 million recorded in 1997, which is helping to mitigate the impact of changing demographics. All of which has positive implications for the domestic economy through higher total employment income and stronger consumer confidence.
Corporate profits and shareholder returns at record highs
Source 1: Datstream
Source 2: Goldman Sachs
Corporate earnings have increased significantly over the past five years and are now at record highs. Sustained economic growth, lower corporate tax rates, a weaker yen and cost cutting have all played a part.
Crucially, earnings have started to decouple from the USD/JPY rate, reflecting a combination of higher top-line growth and improved profitability.
Stronger earnings are also lifting business confidence and supporting growth in investment. Manufacturing companies are prioritising greater efficiency through the upgrading and consolidation of production, while non-manufacturers are focusing on the adoption of labour-saving technology and surging inbound tourism ahead of the 2020 Tokyo Olympics.
Under the third arrow, the government pushed ahead with measures to encourage companies to allocate capital in a more efficient manner with the objective of increasing returns on equity and improving investor stewardship and corporate governance. Reforms included the introduction of the Stewardship Code, the JPX-Nikkei 400 index and the Corporate Governance Code, as well as amendments to the Companies Act
The advances made in corporate governance reforms have seen total shareholder returns increase by more than 80 per cent since 2012 to a record high, and cross shareholdings continually decline.
Jeremy Osborne is investment director of the Fidelity Japanese Values investment trust. The views expressed above are his own and should not be taken as investment advice.