The world’s third largest economy has been in the spotlight since 2012, when Japanese prime minister Shinzō Abe came to power promising a bold stimulus package.
His so-called Abenomics programme, a plan designed to strengthen a country that had suffered from 30 years of on-and-off recession and deflation, has led to Japan’s economy being 2.2 per cent bigger in real terms than when Abe came to power.
To some, it seems the measures are starting to have an effect. After five years of massive fiscal and monetary stimulus, the International Monetary Fund concluded last June that Japan had done enough to stimulate its economy.
Seven quarters of economic expansion (the longest in 16 years), a GDP rise from 1.4 per cent to 2.5 per cent from July to September and an increase in business investment and exports seem to back the IMF’s words. Japan’s reflating measures, aimed at curbing the effects of deflation, have seen corporate profits rebound and stock markets surge.
However, the fiscal and monetary stimulus bolstered by the government since 2013 has failed to lift inflation from near-zero and a lack of wage growth has been followed by a drop in consumer spending. The nation also has an ageing population and a trade-dependent economy, factors that may raise scepticism on its long-term outlook.
But, what do the experts think? Below, we find out fund managers and economists’ views on Japan’s economy and stock market for 2018.
Japanese economy
John Greenwood, chief economist at Invesco Perpetual, said the Japanese economy has had “a decent run lately, with real GDP increasing for six consecutive quarters, the first such extended stretch of growth for over a decade”.
The economist expects low unemployment levels and low wage growth to persist, two facts that provide further evidence that the Phillips curve (which assumes an inverse relationship between rates of unemployment and corresponding rates of inflation) is not a dependable theory of inflation.
Greenwood thinks the country’s persistently low inflation is likely to stay weak and well off the central bank’s 2 per cent target, although it will probably “stay above zero”. He believes economic growth for 2018 should “remain stable (around 1.2 per cent) but lag the US and eurozone”.
Ken Maeda, head of Japanese equities at Schroders, maintained that, as Mr Abe embarks on his new term, he may continue with his aggressive monetary and fiscal policies, which are “very supportive for the Japanese equity market”.
“A further slight acceleration in fiscal spending may also be possible as an offset to the planned increase in consumption tax which is scheduled by Mr Abe for October 2019,” Maeda added.
Japanese markets
Record profits and reforms to corporate governance have helped Japan’s stock market to stay high.
The Japanese yen has also been affected by Abenomics. Under Abe’s reforms, the yen stopped its long-term overvaluation trend (the yen is generally perceived as safe, especially when there’s turmoil in the Chinese markets), which has supported the country’s exporters.
The following graph shows the performance of the yen since Shinzō Abe’s reforms started in 2013.
Performance of yen vs dollar under Abenomics
Source: FE Analytics
According to Columbia Threadneedle Investments deputy global chief investment officer Mark Burgess, Japanese equities are in a ‘sweet spot’ due to “increased strength in corporate earnings and evidence of ongoing corporate reform driving better returns for shareholders”.
Columbia Threadneedle forecasts corporate earnings growth of 8 per cent for Japan next year, supported by higher than expected economic growth, corporate reform, receding political risk and easy monetary policy. Burgess also highlighted the importance of the commitment from a rising number of Japanese corporates to improve return on equity.
Nicholas Price, portfolio manager on the Fidelity Japanese Values investment trust, highlighted that, in terms of corporate fundamentals and valuations, Japanese stocks are “relatively cheap globally”. He referred to the earnings environment as positive, which, he added, “suggests a reasonable level of upside for the market in 2018”.
However, there are signs that momentum in US manufacturing may be peaking, which would suggest slower global economic growth. “Bottom up and individual company fundamentals will be increasingly important as the pace of global growth starts to slow, and I am focusing on companies that can maintain a steady rate of growth and trade on reasonable valuations,” Price added.
He also believes there is no reason to think the current trend of corporate profits upturn and stock markets surge cannot continue, aspect that would typically favour small and mid-cap companies trading at more reasonable valuations. Meanwhile, the premium paid by investors for mega-cap, high-growth companies “may well shrink”, Price noted.
Performance of Japanese vs global equities over 5yrs
Source: FE Analytics
Schroder’s Maeda reminded that the Bank of Japan’s monetary policy – consisting of asset purchase programmes and a policy of yield curve control aimed at maintaining 10-year yields around zero percent – is “unsustainable over the long term” as even some of the central bank’s own aims “conflict with each other”.
“The combination of a fixed amount of JGB purchases together with the yield curve control implies an attempt to target both volume and price simultaneously. In fact, the maintenance of the current yield target necessitates a lower volume of JGB purchases, which is already beginning to show up in the data,” he added.
“The BoJ also continues to be an active buyer of ETFs in the equity market. Although this may be an effective part of the asset purchase programme, it also carries overtones of a market support mechanism which doesn’t appear strictly necessary.”
Investor scepticism and external risks
Although the policy environment for Japanese companies looks favourable for the year ahead, Maeda also pointed out that “external risks linger”.
In Schroders’ view, despite Japan success in building relationships with the Trump administration, “the risk of increased US protectionism and trade retaliation is still there”. “This could easily return to the political agenda if the US administration continues to struggle to deliver on other elements of its growth strategy,” Maeda added.
In addition to these concerns, he highlighted North Korea, which has recently dominated the list of potential risks for Japan: “Although hugely significant, the binary nature of the possible outcomes makes it impossible to effectively price-in this risk to equity portfolios.”
Regarding foreign investors’ scepticism toward the equity market, which persisted until late September this year, the fund manager highlighted that majority of companies produced positive earnings surprises for the period compared to the consensus.
Those facts reinforced Maeda’s belief that initial estimates were “overly conservative” and generated a strong “upward revision cycle for corporate profits”.
“Although some of this profit growth has been discounted in share prices during the recent rally, overall market valuations are still attractive relative to their own history and compared to other global markets,” the fund manager added.