Filed under: Weekly Market Commentary

Five Reasons to Take a Look at Japan

LPL Research - John Lynch Chief Investment Strategist, LPL Financial

Written by Boone Wealth Advisors

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It’s time to take a look at Japan. The Nikkei’s 15-day win streak, its longest on record, has our attention. When thinking about Japan, many who started following markets closely in the 1980s or later know nothing else besides year after year of recession, deflation, and a poorly performing stock market. It’s been a long, slow process but we believe that investing conditions are changing in Japan for the better, making the country’s markets worth a look. This week we discuss five reasons to take a serious look at Japan.

REASON #1: IMPROVING ECONOMY

Economic growth has been improving in Japan with six straight quarters of real gross domestic product (GDP) growth, the longest streak since 2005–2006 [Figure 1]. That streak included a quarter that was essentially flat, so you have to go back to the mid-1990s to find a streak of six quarters with meaningful growth. A potential 1.5% increase in GDP in 2017 (based on Bloomberg consensus forecasts) does not sound like much, but it is the fastest rate of growth since 2013. And for an economy—the world’s third largest—that has been regularly in and out of recession for three decades, it represents progress.

Japan is also making progress in its battle against inflation. Wages have started to pick up, albeit gradually, putting some upward pressure on Japanese interest rates. Although low unemployment in Japan is not newsworthy (historically it has always been low), the quality of jobs is improving. More stimulus and additional structural reforms could help an already improving picture.

REASON #2: MORE ABENOMICS

Prime Minister Shinzo Abe has consolidated power with this weekend’s election victory in which his ruling coalition—his Liberal Democratic Party (LDP) and coalition partner Komeito—retained its twothirds parliamentary majority, providing a mandate for more of Abe’s “three arrows” plan, including: 1) government spending, 2) monetary policy, and 3) structural reforms.

The first arrow, government spending, is tricky given Japan’s heavy debt load. Opposition to more government spending came to light after a proposed sales tax to help pay down debt was met with resistance. But the second arrow is firing on all cylinders, as the Bank of Japan (BOJ) is expected to continue its aggressive securities purchases. The BOJ is also expected to continue capping interest rates at zero to support bank lending and encourage investor risk taking, even as the U.S. and Europe pull back support. This divergence in monetary policy may help keep the value of the yen down, which may help Japanese stocks. Figure 2 shows that when the U.S. dollar is strong versus the yen (higher in the chart), Japanese stocks tend to outperform their U.S. counterparts. A weak yen helps support Japanese exporters, which are critical to the country’s growth prospects (note that Japanese exports rose 13% year over year in August, the latest reported month). For those with the choice, we consider currency-hedged Japanese equity exposure preferred to unhedged, all else equal.

The structural reform arrow is still a work in progress, but deregulation, immigration reform, and encouraging women in the workforce are among some of the policies that can help offset the demographic headwinds of an aging population. A strong military is also a part of Abe’s platform—and helped his LDP party win votes over the weekend in light of the North Korean threat—so we could see more defense spending.

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Written by Boone Wealth Advisors

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