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Japan is going for gold with its economic reforms

Last week, Japan was unveiled as the venue for the 2020 Olympic Games and the announcement is the latest instalment in the ongoing good news story of Japanese economic recovery.

But will Japanese economic recovery be capable of lasting the distance?

The news that Tokyo is to be the Olympic venue helped to push the stockmarket up by 2 per cent the day after the announcement and although it has been predicted that the bid will only add 0.3 per cent to Japanese GDP between now and 2020 – compared with the 3.6 per cent boost seen when Tokyo previously held the games in 1964 – certain sectors of the economy are predicted to benefit.

Schroders Japanese equities product manager Taku Arai says: “Some of the most obvious beneficiaries of the Olympics, such as construction and property companies, had already begun to move before the announcement as Japan had become the bookies’ favourite. However, that did not stop a further rally into these areas, along with sports-goods manufacturers and transportation companies.”

The Japanese stockmarket has been on an upward trajectory since November 2012 following the election of Shinzo Abe and his announcement of a package of radical measures, including a large programme of quantitative easing, to encourage economic growth. 

So far the stockmarket is up 38 per cent year to date and the latest GDP figures show that Abe’s policies have had a strong effect with figures for the second quarter putting annual growth at 3.8 per cent.

Close Brothers Asset Management chief investment office Nancy Curtin says: “The red carpet was rolled out for Japan’s strengthened Q2 GDP figures when the Bank of Japan announced that expectations for inflation are improving. 

“But it is not the only sign of recovery as a result of Shinzo Abe’s initial ‘shock and awe’ approach. Amid strong indications that exports and fixed-asset investments are picking up, public investment is rising and the housing sector looks even more robust. 

“With reflationary tactics now bearing fruit, it is clear that the world’s third-largest economy is heading in the right direction, following in the footsteps of an entrenched recovery in the US. 

“This improvement is also coming through at the consumer level where spending is increasing, reflecting a rise in consumer confidence.”

Retail investor interest in Japan has also increased this year. After negative fund flows for much of 2012, the IMA Japan sector saw new fund inflows of £67m in both June and July – compared with an average of just £0.7m over the previous 12 months.

The Olympic announcement has also given hope that Abe’s government will be spurred on to complete its planned programme of reforms amid concerns that it was running out of steam.

Abe’s programme of economic reform consists of three measures or “arrows”. 

The first two arrows are a large programme of QE and the introduction of fiscal policies such as increased government spending and measures to encourage research and development spending and hiring in the private sector. These are aimed at introducing inflation into the economy and have so far proved very effective.

The third arrow is a package of government reforms to reduce regulation and bureaucracy and stimulate growth in the private sector, progress on which has been slower. 

Concerns had been growing that the government was running out of energy but it is hoped the Olympic target will add fresh impetus to Abe’s programme of reforms.

Henderson Japan Capital Growth fund manager Michael Wood-Martin says: “Although 2020 is some time off, the government should use this accolade [to demonstrate]
that Japan is very much committed not only to rejuvenating economic activity but also to increasing its role in the global economy.”

He adds: “With the eyes of the world watching, there will be added pressure on the government to deliver much-vaunted reforms.”

The Olympic announcement may also help the reforms to bed in by improving the popularity of the government and allowing it to push through some less popular measures such as a planned increase in consumer taxation.

Arai says: “The immediate impact is likely to boost [Abe’s] popularity further and put him in a stronger position to implement ‘third arrow’ measures eagerly anticipated by the stockmarket. 

“Indeed, optimists are already referring to the Olympics as the ‘fourth arrow’.” 

Fund manager’s view: Tony Roberts

After several years of instability in Japanese politics, prime minister Shinzo Abe’s Liberal Democratic Party-led coalition appears to have established a power base that previous governments have lacked. 

The recent upper-house elections have given it majority control over both houses and should provide Abe’s government with a platform for structural change. This is the third arrow of “Abenomics”, the much-vaunted programme designed to kickstart Japan’s economy, with the first two arrows of large-scale monetary easing and fiscal stimulus having already been fired. It was the expectation of change that sparked the Japanese stockmarket’s rise last November. Considerable uncertainty remains about the extent and effectiveness of the government’s growth strategy but, in our view, it simply adds a potential positive to what we have long considered to be an attractive investment story.

Our positive outlook on Japanese equities has been, and continues to be, based on fundamentals. Despite the terrific gains made over the past year, we believe that in general, valuations are not stretched. Consensus forecasts are predicting powerful corporate earnings growth for this fiscal year while Japan is enjoying healthy levels of domestic economic growth.

We expect the Bank of Japan’s monetary policy to remain accommodative and the external environment to continue to be supportive, led by persistent recovery in the US economy.

Equity valuations for Japan’s Topix index are comparable with other developed markets on earnings measures and remain at a significant discount on asset-based multiples.

The corporate earnings outlook is also positive with Bloomberg consensus estimates for growth this year of more than 60 per cent. Japan’s economy is expected to grow by around 2 per cent in 2013, comfortably exceeding expectations for growth in many other developed economies.

Core inflation in Japan was 0.7 per cent year on year in July but it remains some way below the Bank of Japan’s 2 per cent target. With progress towards 2 per cent likely to be challenging, we expect the Bank to maintain an easing bias for some time to come and with the US Federal Reserve priming markets for the tapering of their own asset purchases, this should see the dollar remain firm against the yen. While QE-tapering concerns have caused some volatility in financial markets, it is a signal of stronger underlying performance from the US economy and that is a positive development for Japan’s influential export sector.

“Abenomics” has been an effective catalyst for Japan’s financial markets and if the government succeeds with its growth strategy, there should be long-term positive implications for Japanese companies and their investors. However, looking through these factors, we believe there are some tangible reasons for holding a positive stance on Japanese equities.

Tony Roberts is fund manager in the Japanese equities team at Invesco Perpetual

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