The setting or rising of the Sun….

If the Yen weakens then unless a fund uses a mechanism called hedging then any growth will be lost.

In 2012, Abe swept into power with a super majority. This was significant because it enabled the lower house to push through reforms even if the upper house rejected them.

It was also significant because Japan had suffered years of instability. There had been 14 prime ministers in the 20 years up to 2012. The harsh reality was that unless changes were made the country would head into terminal decline.

The impact of ‘Abenomics’ should not be underestimated and it seems strange to call a snap election if this could derail the reform programme

Abe doesn’t need to call an election

Abe doesn’t need to call an election until 2016 so why risk it now?

There are several reasons:

  1. The government is more popular now than it was in 2012. In 2012 its popularity rating was 27% of the electorate, it is now 37%
  2. The opposition is in disarray – in 2012 its rating was 20%, this is now 6% and there is no credible leader
  3. In 2012 the Abe Government didn’t control the upper house and therefore they needed a Super Majority, they now control the upper house
  4. The election is based around a policy delay on the second stage of VAT hikes which is a popular call

In summary although it caught the markets by surprise everything is in Abe’s favour to win a further four years in office which gives his government more time to implement change.

Is it just another false dawn?

2013 saw strong returns from Japan, however 2014 has seen flat returns as investors take profits.

The Japanese market is controlled by foreign investors, this needs to change and it will, but it takes time.

The reason why it is changing is threefold: firstly the NISA (Nippon Individual Savings Account) has been introduced which encourages investors to invest in the market for five years tax-free; secondly the largest Japanese Pension Fund has gradually reduced its equity exposure, this is now reversing and others will follow. Then thirdly, inflation.

Touching on inflation – for decades GDP has been flat and Japan has suffered from Deflation. The target 2% is important because once inflation comes in it forces people to spend their money, or move from cash to the equity markets.

The analysts believe Abe will come back in and there is much more to come from Japan but care is needed.

Considerations

Wage growth is a key strategy and there are signs that this is happening, but at the moment only in the large multinationals where employees have seen bonuses and good pay rises. But this is only 10% to 15% of the working population.

85% are employed in small to medium sized businesses and the big multinationals need to feed down some of the growth they have had to these smaller companies.

Better pay means potentially more tax and more spending so it is an important part of the overall programme.

The second important aspect is the weakening of the Yen. Currently the Yen is JPY185 to the pound. The Bank of Japan have told sources that they will weaken this further. Estimates are in the medium term to around JPY250 and longer term JPY500.

This means that corporates make bigger profits which helps in reducing the deficit. What many forget is that this will not happen overnight but over the long term (possibly a decade or longer).

Where now for investors

If the Yen weakens then unless a fund uses a mechanism called hedging then any growth will be lost. This showed through 2013 where the Yen weakened in the last six months of the year, and those funds without a hedge showed flat returns. Those with a hedge showed significant returns because they not only benefited from the depreciation on the Yen but also an uplift in asset prices.

If we consider that the stock market in 2012 was at the same level as 1984, and despite some growth it is still considered cheap. This means that when the changes start to filter through the markets will rise further. However, if the Yen depreciates then any growth will be lost unless fund managers use a hedge.

Summary

The snap election may seem strange to some but the reality is that it is perfect timing, and could potentially lock in a further four years for Japan to solidify the changes it needs to implement. For investors if the Bank of Japan does as it has indicated and the Yen depreciates further, and the stock market starts to grow, then the only way to get returns is by using a hedge mechanism. There are funds that do this (Neptune Japan Opportunities is one (which we use), and there are offshore versions of UK Funds like GLG which have a hedged share class), and it is likely more managers will move towards this over time especially if it plays out as expected because they will want to capture the returns.

NOTE: This is written in a personal capacity and reflects the view of the author. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. This is not a recommendation to buy any product or service including any share or fund mentioned. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.

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