Japan - coming off the fence on the side of the bulls
I wrote an update a few weeks ago on Japan (‘Japan - Glass Half Full? Or Empty?') arguing that the market is being pulled between positive and negative factors. At that time, I sat on the fence which way it would fall but things have, as is their wont, moved on.
Most obviously, Prime Minister Abe now looks likely to call an election this autumn on the back of a disorganised opposition and North Korea’s provocation. He may still look at the spectre of Theresa May and draw back, but it is probable that he will win a mandate out to 2021. This would give him another four years to wear down the bureaucrats, particularly in the Ministry of Finance, who form the stoutest opposition to Abenomics.
It is also becoming clearer that the Chinese economy has weathered the travails of 2015 and is on its way back up. The evidence is in the capital flowing back into China, as much as the headline data. This is important to Japan, which since the war has developed from being an outsourced manufacturing offshoot of the US economy (I exaggerate, of course) to a producer of high-end goods for the world. They now find themselves primarily as an intermediate goods producing satellite of greater China’s: for example, consumer goods imports from China are very roughly equivalent to exports of intermediate goods back there, in considerable contrast to Japan’s trade surplus with the US. At a simplistic level, a stronger Chinese economy can only be good for Japan.
There is also the suggestion from our friends at CrossBorder ('Japanese Monetary Policy in a Chinese-Dominated World') that that as their economy has become more linked to China’s, Japanese monetary policy has shifted too. Historically their focus has been on preventing extreme yen strength against the US dollar but it looks as if it is turning to a more pro-cyclical one of aiming for currency stability against a basket of Asian currencies. It may be a symptom of this change that, whereas historically a strong yen/dollar exchange rate has tended to mean a weak Japanese equity market, over the past couple of years we have seen periods of market strength at the same time as the yen has strengthened.
What does this mean for the Japanese equity market? I will come off the fence and suggest it is probably positive overall, mainly because a renewed Abe term reduces uncertainty and it appears that Japan has found an economic model to replace the post-war one based on the US. But I’m not as bullish as some: the scope for policy error remains, foreign investors are no longer underweight and Japanese corporate cashflow remains subdued, albeit slowly improving.