As Prime Minister Shinzo Abe and his Liberal Democratic Party exercise majority control of the Japanese government, they have a unique opportunity to freely implement the “Three Arrows” of “Abenomics”, a three-pronged economic reform effort targeted at reversing almost two decades of slow growth and deflation in the world’s third largest economy. Early signs have been positive, and if Abe and his supporters are successful, Japan could become a compelling investment opportunity for the foreseeable future.
Executive Summary
After WWII, the Japanese economy began what is sometimes referred to as the “Economic Miracle”, a three-decade long period of growth and prosperity. Japanese firms and their management teams were studied around the world as the model of efficiency and an example for all companies and leaders to strive for. In 1989, a bubble in real estate fueled by speculators burst, and the Japanese markets crashed. Since then, the Japanese economy has been in a virtual standstill with more than two decades of stagnant growth and a deflationary environment. Despite lasting more than 20 years, this time period has been referred to as the “Lost Decade.”
With Shinzo Abe’s second term as prime minister, and the 2013 elections resulting in a majority held by Abe’s Liberal Democratic Party, Japan is poised to turn its economic fortunes around. Abe has proposed to propel the Japanese economy through a combination of monetary and fiscal policies and structural changes designed to reduce regulations and stimulate private business growth. If successful, Abe could lead Japan and its economy into a period of robust growth, and potentially provide a perfect opportunity for investors to take part in the rebound of one of the world’s largest economies.
“THE THREE ARROWS”
Prime Minister Abe’s reform plan for Japan centers on:
A monetary easing policy
Large-scale fiscal stimulus measures
Structural reform aimed at reducing regulations on private business, and improving investment conditions
I. MONETARY POLICY
In January 2013, Abe and the Bank of Japan (BOJ) launched an aggressive Quantitative Easing (QE) program, similar to what the Federal Reserve has been doing in the U.S. The BOJ’s goal has been to create an annual inflation rate of 2% and 2% growth in GDP. In April 2013, the BOJ began making asset purchases of 5.8 trillion Yen (approximately $57 billion USD) per month with the goal of doubling the money supply by 20151. This is similar to the Fed’s policy; however, the BOJ is buying ETFs and REITs in addition to bonds. These asset purchases should stimulate prices across all asset classes and, more importantly, devalue the Yen. As an export driven economy, the cheaper the Yen is for other countries, the more attractive Japanese products are to foreigners, providing the potential for significant economic growth. These measures have been successful thus far with year-over-year (YoY) exports up by 15.3%2 and the Yen having fallen 21% vs. the Dollar in the same time period as of December 2013.
II. FISCAL POLICY
In order to stimulate private investment, the second of Abe’s “Three Arrows” is the plan to inject 10.3 trillion Yen (roughly $105 billion USD) into the Japanese economy through infrastructure investment, disaster recovery and rebuilding. Following the devastating Tsunami and nuclear fallout in March 2011, disaster relief and rebuilding Japan will account for approximately 3.8 trillion Yen (almost $39 billion USD). Another 3.1 trillion Yen (approximately $32 billion USD) has been earmarked to stimulate private investment and other measures. This stimulus is expected to increase GDP by 2% annually and help create 600,000 new jobs3. Of course, Abe and his advisors must walk a fine line, as this stimulus package will leave Japan with a 245% debt to GDP ratio4. Abe himself has talked about carefully avoiding “pork-barrel” projects which could undermine the market’s confidence in the desired outcomes for the stimulus measures. However with careful planning and strategic investment, this economic stimulus could help to kick start the next wave of Japanese economic prosperity.
III. STRUCTURAL CHANGES
Japan has been stuck in an almost two-decade long deflationary “supercycle” which has had a major impact on how consumers and corporations view spending and investing. If prices are going to be lower next year, why invest in a new car today or embark on a capital expenditures program now? With his first two arrows designed to create a growing economy, boost inflation and foster investment opportunities, Abe is attempting to change this thought process. This third arrow is designed to create structural changes by reducing regulations and putting incentives in place to encourage investment. It also includes carefully implementing new tax measures to help reduce the large debt burden Japan faces without impacting the economic recovery.
Japan has historically had a business environment filled with government restrictions, anti-competitive laws, bureaucratic interference and inflexibility, and relatively high taxes. While Abe can reduce corporate taxes in a number of ways and create pro-business reforms, Japan has one of the lowest equivalent consumption taxes in the developed world. In September 2013, an increase to 8% was approved by the Japanese government. Future plans may call for increasing this tax to 10% by 2015, depending on how the current increase affects the economy5. Additionally, Abe has personally been in discussion with Japanese corporations asking them to help support the economic recovery by increasing wages by 1%-2% annually. In the early 2000s, the last Japanese recovery before the Financial Crisis, corporate growth did not result in pay increases, as corporations were still in a defensive mode and hoarding cash.
In addition to improving the operating conditions for corporations, Abe is also focused on implementing structural tax and investment changes for Japanese citizens. Beginning in January 2014, Japanese citizens are able to invest up to 5 million yen (approximately $50,000) over a five-year period on a tax-free basis to encourage greater equity ownership. Interest in this Nippon Individual Savings Accounts (NISA) program has been well received by Japanese citizens thus far and should provide greater demand for Japanese equities over time.
INVESTMENT OPPORTUNITY
Prime Minister Abe’s Monetary and Fiscal Policy appear to have been successful, and Japan’s stock market barometer, the Nikkei 225, has responded, posting 25.5% returns in calendar year 2013, and Japan’s GDP grew by an annualized 1.1% in the third quarter of 2013.
In addition to the initial success, there are other factors that could propel economic recovery and investment interest in Japan. The overall level of Japanese equity ownership by individuals and institutions should increase over time. Historically, Japanese citizens have been grossly underweight in stock ownership and instead overwhelmingly favored principal-protected bank deposits for their financial assets. Currently only 8% of roughly $15 trillion in aggregate Japanese household assets are invested in equities and large institutions have similarly low equity exposure in their portfolios. The Japanese government hopes that the NISA accounts will draw approximately $250 billion into the Japanese equity markets6, while Nomura Research Institute estimates that it could be as high as $690 billion. In addition, a general feeling of comfort with an inflationary environment and a market that has appreciation potential should create inflows for the equity markets that will only strengthen over time.
Even foreign investors are under-allocated to the Japanese markets as compared to the Japanese weighting in the EAFE benchmark. This lack of equity exposure creates an opportunity for a major “great rotation” out of fixed income and savings products and into equities as investors, both institutional and retail, become more comfortable with an inflationary environment and a growing economy in Japan.
Final Thoughts
If Prime Minister Abe is able to enact the structural changes that Japan needs, while wisely implementing strategic economic stimulus investments, the 2013 market pop created by easy monetary policy should continue and help fuel a strong Japanese recovery. Abe’s “Three Arrows” appear poised to potentially lead the Japanese economy to new highs; creating an excellent investment thesis for investors who want to focus on a geographic region with above-average upside potential.
1. Bank of Japan, Introduction of the “Quantitative and Qualitative Monetary Easing,” April 2013.
2. Bloomberg.com, JNTBEXPY:IND.3.Ujikane, Keiko. Otsuma, Mayumi. “Japan’s Abe Unveils 10.3 Trillion Yen Fiscal Stimulus: Economy.” Bloomberg.com, January 2013.
4. Evans-Pritchard, Ambrose. “Abenomics has worked wonders but can it save Japan?” The Telegraph.co.uk, July 2013.
5. Reynolds, Isabel. Mogi, Chikako. “Abe Orders Japan’s First Sales-Tax Increase Since ’97: Economy” Bloomberg.com, October 2013.
6. Tsuguo Kohno. “To NISA or not to NISA?” MorganMckinley.co.jp, September, 2013.
This information discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice. Please see additional disclosures on the last page of this document.
About Hennessy Funds
Founded in 1989, Hennessy Funds has a longstanding track record of proven performance and offers a broad range of mutual funds, with strategies that can play a role in nearly every investor’s portfolio allocation. Our line-up includes traditional equity, specialty category and sector funds, as well as more conservative balanced and fixed income products. Each of the Hennessy Funds employs a consistent and repeatable investment process, combining time-tested stock selection strategies with a highly disciplined, team-managed approach. Our goal is to provide products that investors can have confidence in, knowing their money is invested as promised, with their best interest in mind.
Hennessy offers two Japanese equity funds, the Hennessy Japan Fund (HJPNX/HJPIX) and the Hennessy Japan Small Cap Fund (HJPSX), both of which are sub-advised by SPARX Asset Management Co. Ltd. Located in Tokyo, SPARX is one of the largest and most experienced Asian-based asset management specialists.
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Debt-to-GDP Ratio is a measure of a country’s federal debt in relation to its gross domestic product (GDP). Nikkei is Japan’s Nikkei 225 Stock Average, commonly used to measure a price-weighted index comprised of Japan’s top 225 blue-chip companies on the Tokyo Stock Exchange. The MSCI EAFE Index (Morgan Stanley Capital International, Europe, Australasia, Far East) is an index created by Morgan Stanley Capital International (MSCI) that serves as a benchmark of the performance in major international equity markets as represented by 21 major MSCI indexes from Europe, Australia and Southeast Asia. One cannot invest directly in an index.
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