Encouraging signs for the Japanese economy

Andrew Rose, Manager, Schroder Japan Growth

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Japanese equities surged in 2013 on the back of the much-lauded policy of Abenomics – named after newly-elected Prime Minister Shinzo Abe as the market closed out the year at its highest level in more than five years. We have witnessed Japanese growth pick up of late and the battle to fight deflation appears to be one which the government is winning. Recent data point to rising prices. Although this can partly be attributed to higher energy costs following the 2011 tsunami along with the yen’s depreciation, the general trend towards inflation is an encouraging sign for the Japanese economy.

‘Three arrows’

Although there is cause for further optimism in Japanese equities this year, Abe’s ‘three arrows’ policy of aggressive monetary easing, flexible government spending and structural reforms to boost growth have only been partially successful. The first two arrows have found their target as inflation starts to rise and government stimulus boosts growth. However, the final arrow of structural reforms to boost private investment has fallen short of the mark thus far. Talks on the Trans-Pacific Partnership (TPP) free trade agreement have come up against roadblocks as negotiations are held up by vested interests. Although trade talks are always a laborious process, Japan is still expected to eventually join its other Pacific Rim partners in the TPP, albeit after a year or two.

Yen and wage growth

Entering 2014, two facets of the Japanese economy will be in sharp focus – the yen and wage growth. With regards to the currency, the weakness of the yen has been correlated with the recent strength of the stock market. The expectations of tapering in the US by the Federal Reserve have also played a part in its weakness. Whilst the yen is likely to remain under some downward pressure, the degree is likely to be less than 2013, not least because of Japan’s current energy situation and a need to import more fuels in place of nuclear-generated power.

As the country exits deflation, wage growth has now taken centre stage as a key to driving a sustainable rate of inflation through the implementation of Abenomics, as real incomes are still currently falling. Leading indicators in the labour market, as well as anecdotal evidence, have been encouraging while positive news from end-of-year bonuses and spring wage negotiations could provide an impetus for further gains in the market.

Japanese opportunities

The opportunities in this market environment are varied. We favour companies that are looking to increase their domestic capital expenditure, as an expansion in capex is expected this year on the brighter outlook. Government incentives, such as tax breaks for investment spending, also bode well.

There is still space for corporates to increase earnings growth this year and, despite a consumption tax rise being implemented in April, we continue to like retailers on a selected basis. If wage growth does pick up, consumption is likely to follow and a recent 5.5 trillion yen stimulus introduced by the government, to offset the impact of April’s hike, is expected to boost GDP by 1.1%.

Disclaimer

The views and opinions contained herein are those of Andrew Rose, Schroders and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.

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