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Japan: bouncing back or has Abenomics failed?

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27/08/2015
News that Japan's economy shrunk 0.4 per cent in the second quarter of the year has thrust the controversial topic of 'Abenomics' back in the spotlight, and led some to question its effectiveness.

Tipped as the programme to reinvigorate Japan’s economy, this set of aggressive fiscal policies implemented by Prime Minster Shinzo Abe in late 2012, helped steer Japanese shares to a record year in 2013 and drag the country out of recession.

However, the country’s GDP contraction has led to questions around whether the stimulus package is working.

Has Abenomics failed?

Nicholas Weindling, manager of the JPMorgan Japanese Investment Trust, believes it is far too early to assess the efficacy of the initiative. He notes the Bank of Japan’s (BoJ) assessment of the economy has not changed in light of the recent figures.

“BOJ governor Haruhiko Kuroda mentioned two reasons for the weakness in the past quarter – sluggish exports and consumption – and he believes both are transitory,” he says.

Ben Preston, equity analyst at Orbis Investments, believes Abe’s strategy cannot be judged on GDP figures alone.

“It’s tough to make any judgments based on one data point, and economic growth is not the only way to assess the success of Abenomics,” he says.

“What matters for investors is not economic growth, but the impact of policies on companies’ prices and fundamentals. Japan’s experience with Abenomics to date is a great illustration of how economic growth and stockmarket returns can move in very different ways.”

While GDP may have shrunk, other economic data paints a different picture. Weindling notes Japanese companies continued to post healthy profits growth during the quarter, and the latest Tankan report (a survey of Japanese business sentiment published by the BOJ), suggests significant improvement in business confidence, particularly among larger firms.

Sam Perry, senior investment manager of the Pictet Japanese Equities fund, notes share buybacks – where companies re-purchase their own shares – are at an all-time high, and Japanese corporations are more relaxed about using their cash than they have been in years.

As part of the Abenomics programme a new index, the JPX Nikkei 400, was created – only companies offering a good return on equity to shareholders qualifyed for inclusion. Perry believes the index has been a highly effective motivator.

“It’s a badge of honour for Japanese businesses to be included, and they’re vying to get listed,” he says.

The yen & yuan

Abenomics and its success or lack thereof aside, there are other potential headwinds facing Japanese firms.

One is the reverberations of China’s decision earlier this month to devalue its currency, the yuan, in response to a fall in exports.

A cheaper yuan means Chinese consumers and businesses have less money to spend on Japanese exports. It also makes Chinese exports cheaper, putting a competitive pressure on some Japanese firms.

Kwok Chern-Yeh, head of Japanese equities at Aberdeen Asset Management, however, believes the depreciation of the yuan will only impact Japanese companies that have costs denominated in the Chinese currency, or companies that earn revenue in yuan.

“The exact impact will vary from company to company and will also be a function of the exchange rate between the yuan and the yen,” he explains.

Weindling disagrees.

“We should see almost no impact on exports to and from China by local subsidiaries, as they are denominated in yen and dollars, respectively,” he explains.

Perry notes the devaluation negatively impacted the currencies of some of China’s export competitors, but concurs with Weindling’s analysis.

“The yen hasn’t been affected by the yuan’s devaluation – at least not yet,” he states.

US interest rates

Another potential headwind for Japanese firms is the looming Federal Reserve interest rate hike. The hike will make borrowing more expensive,  potentially depressing demand for Japanese goods in the US.

When and by how much rates will increase has long-been speculated. However, Perry believes the hike has been rumoured for so long, it has already been effectively priced in – and markets have been comfortable with the prospect for some time.

Predictive pricing, coupled with an aggressive BOJ quantitative easing programme, has served to depreciate the yen to 124 JPY/USD – which could have positive implications for Japan.

“A weaker yen is great for Japanese exporters because it makes their products more competitive in foreign markets,” Preston explains.

“It also means every dollar or pound of foreign sales is worth more yen back home.”

Chern-Yeh believes a rate rise would be welcome news.

“When rates are raised, it will signal the US economic recovery is on a firmer footing – this can only be a good thing for Japanese companies,” he says.

The long-term outlook

Despite the GDP figure setback, experts believe the long-term outlook for Japan is positive – at least in respect of business.

“It seems Japanese corporates are finally realising the benefits of the yen depreciation and the fall in energy prices,” says Weindling.

“So far, shareholder returns have been driven by corporate earnings growth – we believe they’re set to move on to the next stage, an increase in payout ratios. The earnings growth outlook is attractive.”

Weindling points out the Japanese stock market currently trades on a price-to-earnings (P/E) ratio of 15.7x, based on forecasts for fiscal-year 2015 profits. The US and Europe currently trade on a P/E of 18.5x and 16.6x respectively, meaning the Japanese market trades at a discount to global levels.

Preston believes wider macro analysis or forecasting may not offer the most illuminating insight into the current and future state of Japan.

“No matter the direction of the country’s economy, investors should focus on understanding the price and value of Japanese assets,” he concludes.

“For investors, the direction of Japan’s economy may not matter. It’s critical to remember the stockmarket is not the economy.”

Chern-Yeh likewise believes Japanese businesses can flourish independent of the economy overall.

“Even if Abenomics doesn’t drag the country out of its economic funk, our sense is that it doesn’t matter – the country’s best companies have spent years adapting adverse conditions, and derive most of their earnings from other countries,” he concludes.

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