Is Japan’s economic rebound for real?

Daisuke Nomoto, Senior Portfolio Manager | May 23, 2013

  • Bold monetary easing in Japan has resulted in a shift in sentiment that the Japanese economy will finally come out of the long, dark tunnel.
  • Our research suggests that there may be a modest boost to real income in coming months, which is expected to translate into increased consumer spending.
  • We wouldn’t be surprised if the Japanese equity market takes a breather in the near-term, but this would create a good entry for people who have missed the rally.

The two phrases “Abenomics” and the “BOJ’s Shock and Awe Monetary Easing” are all over the headlines about Japan. Prime Minister Abe unveiled his economic policy late last year calling for a 3% annual nominal gross domestic product (GDP) growth target and an aggressive monetary easing by the BOJ (The Bank of Japan) to achieve 2% inflation. The BOJ unleashed the world’s most intense burst of monetary stimulus last month promising to double the monetary base to 270 trillion yen ($2.7 trillion) by the end of 2014 to defeat deflation.

How effective so far?

Both “Abenomics” and “Shock and Awe Easing” have had a positive effect in that the bold monetary easing has resulted in a shift in sentiment that the Japanese economy will finally come out of the long, dark tunnel. First quarter GDP came in ahead of market expectations at an annualized rate of 3.5%. However, the demand deflator (the amount of GDP growth attributed to price changes) suggests that inflation is still conspicuously absent. Despite weak indications of current inflation, the April consumer confidence survey showed a big jump in the proportion of households expecting inflation to be 2% or even higher in a year’s time. This is exactly what Yale Professor Hamada, a special economic advisor to Abe, means when he says that current policies “work upon people’s expectations,” or in other words, change the deflationary mindset to an inflationary one.

What is supposed to happen next?

“Abenomics” consists of three arrows: 1) bold monetary easing, 2) fiscal stimulus and 3) reforms to stimulate private investment. Our on-the-ground research suggests that there may be a modest boost to real income in coming months, a welcome change to Japanese wage earners who have seen their incomes declining faster than CPI since 1998. The expectation is that higher real wages will translate into increased consumer spending.

What to do from here?

Since we wrote our view on Japan in November 2012 (declining yen driven by aggressive monetary policy leading to market appreciation), the Nikkei index has soared about 70% and the yen has declined about 30%. We wouldn’t be surprised if the Japanese equity market takes a breather in the near-term, but this would create a good entry for people who have missed the rally. We are looking for the following catalysts to produce the next move higher in the stock market:

  1. Growth initiatives from the government to be announced next month which include putting together a policy to address the financial imbalances among the government sector, corporate sector and household sector,
  2. Reinforcement of popular support for the government’s mandate (The LDP’s presumed victory in the upper house election in July),
  3. Decision of government pension funds to increase equity exposure in their long-term strategic asset allocation,
  4. Setting up special economic zones for foreign companies as a part of future growth initiatives coupled with relaxing visa requirements to foreigners (prelude to easing of immigration policy),
  5. Decision on the 2020-Olympic host city (Tokyo, Istanbul or Madrid) in fall 2013, and
  6. Other themes include passage of casino registration, a policy to raise women’s labor participation to address the issue of the structural decline of labor force, etc.

We need to keep watching the Japanese government bond market where yields have spiked up in the last few days, but so far it seems like a “benign yield spike” (yield pick-up driven by economic recovery, not by renewed expectation of deflation), which we guess is exactly what the BOJ Governor Kuroda has been envisioning.

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