After Japan Prime Minister Shinzo Abe’s Liberal Democratic Party coalition government won a sweeping victory in July elections, Japanese equities rallied nearly 9 percent off near-2016 lows and have roughly held the post-election gains since.
Despite the recent gains, the Tokyo stock price index is still down about 15 percent on the year. However, market watchers say the reason for the July rally stems from hopes that Abe will now have enough governmental power to enact the monetary, fiscal and structural reforms he promised when he first came into office in 2012, dubbed “Abenomics.”
The question for investors is whether this is finally the time that Japan’s economy gets back on track, or if Abenomics’ “three arrows of reform” will miss their targets. Analysts who watch the Japanese markets say investors need to be nimble if they are considering entering the space.
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Maybe this time? When Abe first came in to power in 2012, the Bank of Japan launched a massive monetary stimulus program that continues to this day, with the central bank pushing a negative interest policy to try to create spending. It hasn’t had much luck, says Chen Zhao, co-director of global macro research at Brandywine Global in Philadelphia.
“Monetary policy is pushing on a string. Without demand, we’ve proven that doesn’t work,” he says.
Nearly all global central banks, including the U.S. Federal Reserve, enacted some sort of extraordinary monetary policy in the wake of the global financial crisis, and many continue to have these plans in place. But Japan’s stimulus program dwarfs all others, says, John De Clue chief investment officer, The Private Client Reserve of U.S. Bank in Minneapolis.
“It’s astonishing what the Bank of Japan has done. Their program, in percentage of GDP, (gross domestic product) far exceeds what the Federal Reserve has done here in terms of quantitative easing and even ECB (European Central Bank) as well, way beyond,” De Clue says.
Zhao says Japanese stock markets rallied in July in anticipation of strong fiscal policy measures to kick-start the economy. In early August, Abe’s cabinet approved 13.5 trillion yen ($132.04 billion) in fiscal measures, including cash payouts to low-income earners and infrastructure spending, according to news reports. Japanese stock buyers initially were disappointed with the news, although equities have since rebounded.
Christopher Vecchio, currency analyst at DailyFX, says part of the issue is how the fiscal policy stimulus was created.
“Much of the fiscal outlays will be in the form of lending rather than direct spending, and the relatively small size of the extra budget offers little confidence for a break from current norms,” he says.
Pat O’Hare, chief market analyst at Briefing.com in Chicago, says investors are prudent to be cautious.
“What you see going on with Japan’s stock market is perhaps more tactical in nature as far as buying it, as opposed to truly being strategic and truly believing in the long-term opportunity in that market. Because the Japanese economy has been such a disappointment for so long, it’s the epitome of a show-me story,” he says.
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Second quarter gross domestic product data out Monday showed Japan’s economy grew at an annualized rate of 0.2 percent, down sharply from the first quarter’s 2 percent growth rate.
There are also some concerns that Abe’s coalition may get distracted from reforms, De Clue says.
“There are a lot of concerns that (his power) might get squandered on revising the constitution, saber-rattling (with China),” he says. “Can he put his firepower in reforms, or will he get distracted with issues that are politically charged and could be a distraction to what they really need to do, which is fix the system, basically.”
How to play it. De Clue says Japanese equities do have times when they perform well, even though Japan’s economy has been stagnant for the last two decades.
“You’ve got to think about this in terms of short-term, long-term as you do in any investment program,” he says.
Further, Zhao, De Clue and O’Hare say U.S. investors must also be aware the role currency plays in these investments.
“If we’re selling dollars to effectively buy yen, and even though investors aren’t aware of that, that’s basically what’s happening under the table, you could wind up having the market perform well, but losing an equivalent amount on the currency,” De Clue says.
To invest in Japan, De Clue and O’Hare recommend sticking with funds that handle the currency hedging, rather than trying to buy individual share names.
O’Hare says examples of exchange-traded funds that offset the impact of currency factors include the Wisdom Tree Japan Hedged Equity Fund (ticker: DXJ) and the iShares MSCI Japan ETF (EWJ). Between the two ETFs, the iShares fund has “done relatively better (this year) and it gives someone exposure to the large-cap universe in the Japanese stock market,” he says.
“The ETF universe for the retail investor is likely your best avenue for participating in the Japanese market,” he says.
Investors also need to think about their short-term and long-term interests. O’Hare sees any Japanese investments as tactical, or short term, while De Clue says there might be some long-term buys.
“Japan’s market right now is one an investor wants to date, but doesn’t want to marry. Use that type of perspective and see where it takes you and reserve the right to end that relationship when necessary to do so,” O’Hare says.
De Clue says he believes investors who want to build a globally diverse portfolio need to have some Japanese exposure, as long as the currency is hedged.
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“On a longer-term basis, valuations are very attractive in the Japanese equity markets,” he says. “You could easily make the argument even with the problems in Europe, Japanese stocks are relatively cheap compared not just to the U.S., but Europe.”
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Is it Time for Investors to Return To Japan? originally appeared on usnews.com
