In the wake of Japan’s weekend election, Asia specialist Hugh Young believes investors have plenty to focus on across the region.
Japan, along with the wider Asian market, is something of a curate’s egg for investors, offering excellent opportunities and challenges too. The decision of Japan’s Prime Minister, Shinzo Abe, to hold an election at the weekend is, in many ways, a symptom of this mixed state of affairs. The architect of the nation’s rescue policy, known as Abenomics, consolidated his position before the tide of support that first swept him into power in 2012 went out. After riding back in for another term, Abe will now have to redouble his efforts to overcome recession and deflation with an ultra-loose monetary policy that has continued to lift Japanese equities.
Hugh Young of Aberdeen Asset Management Asia, who manages the Far East fund for St. James’s Place, described the snap election as an astute tactical gambit by Abe that will allow him to push through some of the “less palatable” parts of his reforms. “He has cashed in on his current popularity, albeit rapidly declining, to lock in another term in office,” says Young. The mandate should also give Abe the time to pursue other controversial policies, he adds, in particular reopening Japan’s nuclear power plants. Abe will also want to postpone the second part of the increase in consumption tax, which, since April, has backfired and dampened consumer activity.
“These policies are crucial to prevent the economy from spiralling deeper into recession and to provide a more conducive environment for Abenomics to succeed,” says Young. “But they come at a heavy cost.” The consumption tax revenue had been intended to reduce Japan’s public debt – the highest in the world due to its ageing population – and a dwindling tax base means more demand on pensions and healthcare. “Arguably, the gains from a healthier economy over the long haul should outweigh the foregone tax revenue in the near term,” he adds.
Investors will also be looking at the Bank of Japan’s latest round of quantitative easing, and the decision by the Government Pension Investment Fund to increase equity allocation targets. “Overall, these policies are positive for the stock market and share prices have rallied,” says Young. “But there may be room for further gains.” For starters, the Tokyo stock market index, TOPIX, is trading at well below pre-financial crisis levels. “On an absolute basis, we think TOPIX stocks are not expensive,” he adds. “On a forward price-to-earnings basis, the index is still trading below its seven-year average.”
But, in the longer term, the situation appears less than rosy, says Young. “While Abenomics’ first two policy ‘arrows’ of expansionary fiscal and monetary measures lifted the economy temporarily, the third – made up of a series of wide-ranging reforms – has failed to find its mark,” he adds. “As a result, the impact from the first two arrows has dissipated quickly and the economy slipped back into recession in the third quarter. Abe’s early election ploy will now buy his reforms more time.”
Young also harbours concerns for the state of the world’s second-largest economy across the East China Sea. “There are worries about whether China is heading for tougher times,” he observes. Amid continued unease that the slowing economy could undergo a hard landing, the People’s Bank of China has had to act decisively and cut interest rates. “This seems to be a continuation of policymakers’ strategy of employing rounds of incremental ‘mini-stimulus’,” observes Young. “They have chosen not to use more aggressive measures, such as adjusting the reserve requirement ratio and/or loan-to-deposit ratio for banks.” As such, it is too early to say whether existing measures are sufficient, he argues. “Also, while the recent interest rate cut will reduce the risk of an economic slump, it could delay much-needed structural reform.”
Hong Kong rising
Meanwhile, amid a recent bout of volatility in China’s markets, the long-awaited link between the Shanghai and Hong Kong stock markets has been officially established. Young says that it is too early to judge the effectiveness of the scheme, but believes it will be crucial to China’s currency and market liberalisation plans – and will enhance the status of Hong Kong. “It offers a convenient way to invest in the mainland,” he adds. “Significantly, it is a strategic first step towards internationalising China’s capital markets; it expands investment choices for mainland investors; and paves the way for the further opening up of the renminbi.”
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The opinions expressed are those of Hugh Young and are subject to market or economic changes. This material is not a recommendation, or intended to be relied upon as a forecast, research or advice. The views are not necessarily shared by other investment managers or St. James's Place Wealth Management.