Schroders Quickview: Important decisions for Japanese Prime Minister Abe
Prime Minister Shinzo Abe has postponed a planned consumption tax increase and called a snap general election. While this has caused further market volatility, we still see a number of positive factors supporting the equity market.
The decision to postpone a further consumption tax increase, originally planned for October 2015, comes amidst negative growth for the Japanese economy. His decision to call a snap election in the lower house has been a concerted effort to gain public support for the consumption tax postponement and to reinforce the popular mandate of ‘Abenomics’ as a whole.
We can see government debt problems and a potential exit of the Bank of Japan’s (BOJ) huge monetary easing posing issues for the Japanese economy over the mid- to long-term.
The election will be held on 14 December and Abe is committed to presenting his case to the public on his plans to revitalise the Japanese economy. The consumption tax increase from 8% to 10% will be postponed to April 2017 to allow more time for Abenomics to have its desired effect, and he has stated that there would be no further delay to this date. His speech on Tuesday evening was well received and it looks likely that he will win a majority.
We feel there is no justification to call an election at this point other than purely political reasons in terms of timing, given Abe’s dominant majority in both the upper and lower houses. We are also concerned about the uncertainty ahead of 14 December as well as the delay in the progress of Abe’s growth strategy. Having said that, if Abe wins the election then his party will be given another four years of political stability. Despite this, we think it is imperative that he focuses on economic policy and executes his growth strategy in the coming years.
The decision to postpone the consumption tax increase can be justified by the much weaker-than-expected GDP data for the third quarter as well as other poor consumer spending data. Two consecutive quarters of negative GDP growth, which Japan has experienced since the increase of consumption tax last April, had not been expected.
With Abe’s decision to postpone the next consumption tax increase, there will be time to see the benefits of higher wages over the next two years and we expect Japan’s economy to pick up steam next year. We can see government debt problems and a potential exit of the Bank of Japan’s (BOJ) huge monetary easing posing issues for the Japanese economy over the mid- to long-term, but they will not add immediate risk to the market.
The market has been volatile since the BOJ’s surprise announcement of additional easing at the end of October, and Abe’s consumption tax decision and election have added further volatility to the market. This has primarily been driven by short-term investors and therefore the risk of short-term profit-taking towards the end of year may need to be monitored carefully.
However, we have seen solid growth of corporate earnings in the six months from April to September when GDP fell sharply, and we expect further upward revisions in corporate earnings with a large push from the recent yen weakness. Given the robust corporate fundamentals, the valuation of the Japanese equity market is not expensive – even after the strong rally since the end of October. More importantly, we have been encouraged by the strong momentum in improving corporate governance in Japan. We have seen an increasing number of companies announcing share buybacks to reduce their cash pile and improve return-on-equity.
Another positive for the market is the turnaround of the Japanese institutional investors’ holdings of Japanese equities as GPIF (Japan’s Government Pension Investment Fund) has made the decision to substantially raise its allocation to Japanese equities