The debate around the strength and purpose of the reform process in Japan continues, with the market and currency both unnerving investors this year. A stronger yen has been a reflection of weakening global confidence and generating inflation also continues to be difficult, as evidenced by the current rate of 0 per cent. The Bank of Japan has already pushed out the expected date for reaching its 2 per cent target to November.
Many investors are predicting an announcement of further monetary stimulus in the coming months, following the poor fourth-quarter GDP growth figure and the move to cut the benchmark interest rate to negative in January.
Should further quantitative easing be announced – and in sufficient size – it could be positive for markets and negative for the currency. However, expectations may already have been priced in and, as in Europe, QE expansion seems to be having less of an effect each time.
Many commentators say the Japanese stockmarket’s continuing volatility has come as a result of a lack of institutional buyers of domestic equities. But despite the volatility, the overall market environment is seeing some improvement.
The government has received a recent boost as the $1.2trn (£84bn)state pension fund reported its biggest quarterly gain in a year: a 3.56 per cent return on investment in the three months to December, the primary source of which was the rise in domestic equities. However, unless shares rally by the end of this month, the current quarter will see negative returns, as Tokyo shares have fallen 15 per cent this year.
A new pension fund index (Nikkei 400 index) includes measures such as looking at a company’s return on equity for inclusion, so the days of Japanese company management ignoring the needs of outside investors seem well and truly over.
Corporate governance is also on an upward trend, leading to greater capital efficiency, and total dividends paid by listed companies will rise by over 10 per cent for the sixth straight year. All these changes are positive, but caution is still required as there remain many uncompetitive companies failing to adapt to the new environment.
Valuations are attractive relative to their history, particularly on a price-to-book basis. What is more, Japan is one of the few markets where companies have continued to demonstrate earnings growth, partly owing to the significant weakening of the currency (until recently) but also thanks to greater concentration on shareholder value and corporate governance.
Further positive market movements will depend on foreign investor sentiment and whether there are more signs that the government and the central bank’s policies can lead the economy into a period of sustained growth.
Saying that, there is some evidence the Abenomics experiment is running out of steam, with the recent sale of 10-year bonds at a government auction at yields below zero for the first time. This is reflective of a collapse in borrowing costs globally, as central banks take ever more unusual steps to stimulate growth. Japan is the second country after Switzerland to do this and it looks increasingly as if the government is resorting to more extreme measures.
The structural reform programme continues but it needs to achieve greater acceptance across a wider base of companies and domestic investors to keep the momentum.
Abenomics has certainly come under greater scrutiny in the past six months over the effectiveness of policies to stimulate growth and inflation, and as long policymakers continue to take more extreme measures to achieve this, such scrutiny will only increase.
Graham O’Neill is director at RSMR