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Abe wins: a boost for Japan

 

 

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The positive outcome of the election gives Mr Abe a stronger mandate to pursue his agenda.

 

 

 

 

 

 

 

 

 

 

 

 

 

The stock market will continue to price in a global cyclical recovery, after the snap election result reduced the political tail risk.

 

 

 

 

 

What is your view on the outcome of the Japanese election?

Akio YOSHINO: The Liberal Democratic Party (LDP) reported a landslide victory in the Lower House election, taking advantage of fragmenting in the opposition parties. The ruling coalition (LDP-Komeito) maintained its two-thirds majority in the House (313 of the 465 seats). The victory in the Lower House elections gives the ruling coalition control of both Houses of the Diet, the House of Representatives (Lower) and the House of Councilors (Upper). Having majorities in both chambers allows Prime Minister Abe to be flexible with regard to passing legislation. Also, the PM has greater discretion with regard to revising the constitution, though this is a controversial issue.

 

Do you expect the new Abe administration to continue its pro-growth and reform agenda?

Akio YOSHINO: Yes, the positive outcome of the election gives Mr Abe a stronger mandate to pursue his agenda. In contrast to the apparent strength of the LDP, Prime Minister Abe’s image had been threatened by private school-related scandals that negatively affected his government’s popularity. In an attempt to restore his popularity with citizens, Mr Abe recently increased the focus on social security reform. He promoted the “Work Style Reform”, which includes supporting female workers and securing additional child care capacity. Government spending for education is expected to rise. A large part of the revenue from the increase in the consumption tax (from 8% to 10% due in October 2019) will be devoted to financing these productivity-enhancing reforms. The fact that revenue will not be used for debt reduction could lead to some concerns about deteriorating fiscal discipline.

The government is also expected to increase its support for small/medium sized firms which could be affected by the increase in the consumption tax. The new administration is also expected to support the agriculture sector, which could be hit by changes regarding the Trans-Pacific Partnership agreement and by the EPA1 with the Eurozone.

1 - Economic Partnership Agreement.

Would you expect the Bank of Japan to maintain its stimulative reflation strategy?

Akio YOSHINO: Yes, the ruling coalition’s victory increases the chance that the current Governor of the Bank of Japan (BoJ), Mr Kuroda, will be reappointed next year for a second term. The government is eager to keep him at the top of the central bank at least for a few years in order to maintain the low interest rate environment. The BOJ foresees that core CPI will reach 2% in fiscal year 2019. This is consistent with Mr Kuroda remaining as governor until the goal is fulfilled.

On the other hand, some adjustment to the yield curve control (YCC) framework is likely and consistent with the strengthening of the economy and/or acceleration in inflation (or in inflation expectations). We see three options. Plan A: the monetary authority allows the benchmark yield to well exceed zero (say, 0.15%) without any change in the statement. Plan B: the BOJ declares a change in the designated level of the 10-year yield. Plan C: The BOJ switches target instrument to, say, the five-year bond from the 10 year, allowing greater flexibility at the longer end of the curve. Any of these cases would give financial institutions advantages as a result of a steeper yield curve. Based on this process, the BOJ will be forced to officially admit that promised Japanese Government Bond (JGB) purchases of JPY80tn per year are excessive and likely not feasible. Therefore, QQE (Qualitative Quantitative Easing) policy will be automatically altered once the BOJ changes the YCC scheme.

What will the drivers of the stock market be over the next months? 

Yasunori IWANAGA: The stock market will likely continue to price in a global cyclical recovery, after the snap election result reduced the political “tail risk”. We may see phases of profit taking, but the fundamentals for the stock market look to be positive. More companies are likely to revise their earnings outlook as business sentiment improves while the Nikkei has just managed to return to a Price Earnings (PE) ratio at 15x, which is about the three-year average.

A couple of points to note going forward. One is excess cash on the corporate balance sheet. Taxation on retained earnings resurfaced during the election campaign period as a way to encourage risk-taking. These forces should generate continuing buybacks and dividend increases.

The second issue relates to the BOJ. The central bank has no room to seek a normalization of its policy, with the CPI undershooting the target. The yen, therefore, will be biased towards depreciation (provided there is no imminent threat from North Korea) on the back of the expectation that the Fed will raise rates in December as well as balance sheet reductions. Sector-wise, cyclicals remain attractive i.e., auto, information technologies and machinery (to a lesser extent) - on the back of steady demand overseas - in particular, East Asia.

How do Japanese equities fit into a multi-asset approach?

Francesco Sandrini: With a multi-asset perspective, we believe that investors should favor risk assets, and, in particular, the equity market, consistent with a base-case scenario of asset reflation persisting over the next quarter and a gradual move towards a late cycle scenario in 2018. Japanese equities are among our top preference (together with European and Emerging Market equities). We see them being supported by the strong momentum of the Japanese economy and positive earnings growth for the corporate sector. The election outcome, favoring stability and giving PM Abe a new term to pursue Abenomics, could further boost the reflation story. From a valuation perspective, Japanese stocks exhibit higher upside potential for multiples re-rating compared to US stocks in the context of a transition to a late-cycle phase, which we expect to gradually unfold over the next quarters. Market positioning also remains supportive: we expect foreign investors, – until recently net sellers of Japanese stocks year to date - to be reassured by the increased political stability.

With the contribution of:
Giuseppina Marinotti ,
Amundi Investment Insights Unit Specialist

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SANDRINI Francesco , Head of Multi-Asset Balanced, Income & Real Return
YOSHINO Akio , Equity Research and Strategy at Amundi Japan
IWANAGA Yasunori , CFA, CIO Amundi Japan
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Abe wins: a boost for Japan
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