What the Japanese Election Means for Investors
Japanese prime minister Shinzo Abe’s right-wing Liberal Democratic Party (LDP) and its coalition partner, New Komeito, cruised to a big win in elections on Sunday, capturing majority control of the upper house of Japan’s parliament (called the Diet).
The LDP, with New Komeito’s support, now controls both houses of the Diet, ending gridlock that had been in place since 2007, when the LDP was defeated by the opposition Democratic Party in the upper house. Abe stepped down shortly that loss, but now his latest administration doesn’t have to worry about another election until 2016.
“Abenomics” Has Given Japan a Shot in the Arm…
Abe’s economic reforms, dubbed “Abenomics,” have been credited with improving the world’s third-largest economy, which has been trapped in a deflationary spiral for the past 15 years.
Abenomics consists of three parts, or “arrows,” as he refers to them: fiscal stimulus, monetary stimulus and structural reform. After he returned to office in December, Abe shot the first arrow: a 10.3-trillion-yen ($116-billion U.S.) stimulus plan that the government claimed would boost Japan’s GDP by 2% and create 600,000 jobs—although Citigroup (NYSE: C), later estimated that the job total would be closer to 100,000.
In addition, the Bank of Japan, under newly installed chairman Haruhiko Kuroda (who was nominated by Abe), has initiated a new quantitative easing program, similar to that of the U.S. Federal Reserve. Under this plan, the bank is purchasing 7 trillion yen of government bonds each month. The aim is to double the country’s money supply, with goal of pushing Japan’s inflation rate up to 2% within two years. To put that in perspective, Japanese inflation was -0.3% in June.
So far, these policies have had their intended effect: the yen has dropped about 20% against the U.S. dollar in the past eight months, to around 100 yen to one greenback.
“This is an exchange sweet spot for Japan’s major exporters, whose products are now cheaper for foreign buyers and whose domestic sales will pick up along with the economy,” wrote Investing Daily analyst Benjamin Shepherd in a June 17 article in our Benjamin Shepherd’s Wall Street newsletter.
“Quite suddenly, Japan has become one of the fastest-growing developed economies, in what is a major role reversal,” he added. “Japan’s economy grew 3.5% the first quarter of 2013, triple the 1% rate at the end of 2012 and significantly more than what analysts expected.”
The Nikkei 225 index has also performed well, rising over 40% since the beginning of the year.
…But Will Abe Follow Through?
Abenomics’ third pillar, structural reform, has faced resistance from the Democratic Party as well as some supporters of his own LDP. They include potentially divisive changes, such as lowering corporate tax rates and making it easier for companies to fire workers, as well as other measures, such as moves to attract more women to the workforce.
“It’s done. Abe is in full control now,” HSBC economist Frederic Neumann wrote in a research note quoted by CNN Money. “Yet his real test still lies ahead. He must urgently implement far-reaching reforms to make his economic revival stick.”
There are also concerns that with command of the Diet, Abe will take his eye off the economy and focus on more nationalist items of his agenda, which include amending Japan’s pacifist postwar constitution.
Abe himself, however, sounded focused on economic issues in the wake of his win Sunday: “It is a historic project,” he said. “We will concentrate on that. We won’t be able to strengthen the financial base for social security without a strong economy.”
For investors looking to profit from a Japanese rebound, Shepherd likes the iShares MSCI Japan Index ETF (NYSE: EWJ), due to its emphasis on export-oriented industrial firms and domestic consumer spending. The Industrial sector accounts for about 19% of the ETF’s holdings, while Consumer Discretionary and Consumer Staples make up a combined 28%.
The ETF aims to track the performance of publicly traded stocks in the Japanese market, minus fees and expenses, as measured by the MSCI Japan Index. The fund’s holdings consist of 315 large- and mid-cap Japanese companies.
From largest to smallest, its top 10 holdings include Toyota Motor, Mitsubishi UFJ Financial Group, Honda, Sumitomo Mitsui Financial Group, Softbank Corp., Mizuho Financial Group, Japan Tobacco, Canon, Takeda Pharmaceutical Co. and Mitsubishi Estate Co.
The fund’s expense ratio is 0.53%. The units are up about 23% since the start of 2013.
“With Japan’s huge stimulus program already making progress in righting the Japanese economy, the country is likely to be one of the world’s top-performing developed markets for some time to come,” wrote Shepherd. “Note, however, that EWJ is volatile, with drops of 5% to 7% in one day, so it’s for a small amount of money you can afford to put at risk.”