09Sep 2016

Kwok Chern-Yeh,
Head of Investment Management,
Japan

Japanese equities: Why firms can flourish after Abe’s fiscal throwback

Japan’s redeployment of fiscal stimulus this month was a tacit admission by Prime Minister Shinzo Abe that his plan to revitalise the country’s economy – dubbed Abenomics – was failing, if not face down.

Nothing so far – including the adoption of negative interest rates – has delivered the Bank of Japan’s 2% inflation-target and sustained economic growth. So in the end it was back to the drawing board, and to the same coordinated fiscal and monetary action plan that accompanied Abenomics’ launch back in January 2013.

At the start of this month Abe unleashed a ¥28 trillion (US$278 billion) stimulus package that featured some ¥7.5 trillion in direct government spending. There were grounds for encouragement in a renewed focus on structural reform: measures to upgrade port facilities to improve access for large cruise ships; promotion of hotel construction to boost tourism; exploration of ways to increase agricultural and fishery exports; and development of advanced regional transport networks. These are important for enhancing productivity to support sustained growth.

Such measures may help contribute to a 1.5 percentage point boost to GDP over the next two years. The BOJ’s expanded programme to buy exchange-traded funds should prop up stock prices, with the prospect of further support to come. But the central bank may have to concede that 2% inflation won’t be achieved by the latest target date of end-March 2018.

Despite all this, the market wasn’t impressed. It says something about the lack of confidence in policymakers (and how little room for manoeuvre the BOJ has left) that such monetary and fiscal stimuli barely registered with investors. The yen has been strengthening when by all rights it should be weakening.

One reason may be because of a growing realisation that unless Abe makes significant headway with structural reforms, stimulus on its own won’t make a difference. There is no quick fix for Japan, a nation with a net-debt-to-GDP ratio of 160%. An ageing population means domestic markets are shrinking, along with the workforce.

The government has sought to encourage women and caregivers back into employment. Other measures that authorities could consider include allowing freer movement of labour into the country. If Japan is to reclaim a growing share of exports globally, it must raise productivity and rediscover the innovative edge it used to be famous for.

That said there are still plenty of companies in Japan that deliver decent growth and profits. These are companies that learned hard-won lessons in fortitude and resilience during more than two decades of economic stagnation.

Many are cash-rich: when Japan’s asset price bubble burst some 25 years ago, sources of debt refinancing dried up and companies were forced to prioritise internal cash generation just to survive. In the years since these companies have paid down their debts and now boast strong balance sheets with positive cash flow.

Many of the very best companies have moved some of their operations overseas in pursuit of new markets and to lower production costs, not just household names but specialist manufacturers and suppliers, too. Those operating in the faster-growing emerging markets are often best placed to capitalise on changes in the dynamics of global consumption.

Furthermore, Japanese firms have become more receptive to international best practice with regards to corporate governance: dividend pay outs and share buybacks have been on the rise, and some senior executives are more accessible than they were in the past.

We have encouraged our more cash-rich holdings to pay out surplus capital through special dividends instead of buybacks, which may provide a short-term boost to the share price but can amount to misallocation of capital if the shares were bought at unfavourable valuations.

So regardless of what the government or the central bank does, or any misgivings over the state of the economy, we continue to find investment opportunities in this market. The very best companies aren’t waiting on Abe; and neither should we.

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