The sudden resignation of Japan’s longest-serving prime minister, Shinzo Abe, has jolted investors’ confidence in local equities. The benchmark Topix index dropped 1.66% on the day of the announcement last Friday (August 28), and the yen, seen as a safe-haven during volatile times, rose from 106.50 to 105.40 against the US dollar.
Nervousness is understandable given that the prime minister salvaged the Japanese economy from decades of stagnation, ended deflation, and provided support for the local stock market. The Topix had surged close to 90% since he took office in December 2012.
Abe's bold economic policies, which included the move by the Bank of Japan (BoJ) to buy Japanese equity exchange-traded funds (ETFs), have been so closely intertwined with his political identity, that together they are called Abenomics.
Uncertainty surrounding his successor, however, and the future of Abenomics, has led some experts to argue that a revolving door could haunt the Japanese government again, just as it did before Abe took over. Japan had six prime ministers in the preceding six years.
Abe's departure could also increase volatility in an already fragile economy. The Covid-19 pandemic dragged Japan’s second-quarter GDP down a record 27.8%.
AsianInvestor invited economists, Japanese equity specialists and fixed income experts to share their views on how prime minister Abe’s departure will impact local assets and the challenges that investors face.
The following extracts have been edited for clarity and brevity.
Hiroshi Yokotani, managing director of portfolio strategy and business management for Asia Pacific
State Street Global Advisors (Japan)
Most of Shinzo Abe’s achievements in his almost eight-year term as prime minister were in economic and foreign policy. Abe’s economic policy mix was an extremely accommodative monetary policy and moderate fiscal policy, which led to an increase in stock prices, a lower Japanese government bond (JGB) yield and an appreciation of the yen.
Abe’s achievements in foreign policy included facilitating a good relationship with the US, Europe and most countries in Asia Pacific. This was proved by the unprecedented number of farewell messages sent from foreign political leaders.
Yoshihide Suga is now a frontrunner to succeed Abe and is competing with Shigeru Ishiba and Fumio Kishida. Were Suga to be elected, no significant changes in policy would be expected, which would translate into a minimal market impact. Under Ishiba or Kishida’s leadership, the ministry of finance (MOF) might regain its political power with the potential for more fiscal discipline. Were this scenario to play out, investors would need to be warier of stock prices.
Whoever replaces Abe, investors should keep eyes on who will be appointed as the minister of foreign affairs and the MOF. If the new prime minister fails to maintain political leadership, the risk for the Japanese market will be even lower stock prices and more appreciation of the yen. The risk in the JGB market should remain low.
Jason Liu, head of CIO office for Asia Pacific, international private bank
We believe that the BoJ is likely to retain current policies (yield curve control and ample liquidity support). Bond purchases above the previous ¥80 trillion ($750 million) target, however, are unlikely as the volume should be driven by yield curve control.
In the short term, Japanese equities may experience some volatility, but they should be supported by BoJ’s buying of ETFs. In addition, Japanese companies are generally in a stronger financial position than in the 2008 financial crisis, so investor appeal should still remain. International investors are focused on cyclical industrial and IT companies.
The low volatility trading environment in JGBs is set to continue, given that the yen remains range-bound versus the US dollar. The 10-year JGB yield has been trading at or close to the 0% target for some time now and the BoJ will continue to buy as many bonds as is necessary to keep the yield curve low and stable. But it is hard for the BoJ to steepen the curve on a sustainable basis so investors will continue to search for carry on the curve.
The yen's safe-haven characteristics have declined, most notably against the US dollar, partly due to Japanese investor demand for US assets. We expect a rise in hedge ratios to occur, which should support the yen ... with our forecast for August 2021 at 105 to the US dollar.
Some of the biggest challenges for the Japanese economy are to cut the massive debt burden, reverse weak productivity growth, focus on corporate governance reforms, and reduce the structural problems posed by ageing demographics.
Paul Hsiao, global economist
We expect the Bank of Japan to maintain policy continuity across the next six to 12 months and to be much more in tune with the economic cycle than the political cycle. While Abe is stepping down, the Bank of Japan governor, Haruhiko Kuroda, an Abe appointee, is set to serve out the rest of his term, which expires in April 2023. This should anchor markets while Japan searches for a new prime minister.
Moreover, the current front runner, chief secretary Yoshihide Suga, an Abe insider, is largely expected to continue Abenomics compared with another candidate, former defence minister Ishiba, who has criticised the Bank of Japan’s (BoJ) ultra-low rate policy in the past. Given the Covid-19 overhang and mild yen appreciation this year, we do not expect the bank to alter its extremely dovish policy settings in the next six to 12 months.
For equities, Japanese stocks have historically been an outsized benefactor from a strong cyclical recovery. Earnings have also improved under strong corporate governance reform championed by Abe, which is likely to remain, and local equities also benefit from the BoJ's expansive asset purchase programme. Key risks are the Covid-19 trajectory, the global trade environment, and the strength of the Japanese yen.
In fixed income, Japanese government bond yields can be an attractive hedge for some investors given its low volatility under the BoJ's yield curve control programme.
Alicia García Herrero, chief economist for Asia Pacific
Prime minister Abe announced his resignation with undelivered promises under Abenomics.
Fiscal reform, the second arrow [of Abe's three arrows, or pillars of economic reform], has barely happened. Covid-19 might be blamed for deteriorating fiscal positions. His cabinet, however, delayed the consumption tax hike twice, postponing the fiscal reforms. The government even launched small fiscal stimulus packages to weaken the adverse effects of the tax hikes. With public debt remaining at more than 200% of GDP, Abe's push for fiscal consolidation has never been wholehearted.
Structural reform, the third arrow, is even less obvious. Wage growth has remained stagnant, which is in line with very low labour productivity. The much-needed reform of Japan’s dual labour market never bore fruit. Furthermore, without meaningful deregulation measures, total factor productivity has even fallen. Consequently, Japan’s potential growth has continued to decline.
The BoJ has avoided getting into deeper negative territory. Nevertheless, without the two arrows, monetary policy cannot bring Japan back to a sustainable growth and inflation path.
Paul Brain, head of fixed income
Newton Investment Management
We do not anticipate a change in monetary policy following Shinzo Abe’s resignation unless there is a change in the Bank of Japan leadership.
The Japanese bond market drivers are unlikely to change because of his resignation. The main influence will be the fact that the other global bond markets have converged down to Japanese yield levels which makes them less attractive to Japanese investors.
The biggest challenges going forward will be on the tax-raising side. As with other countries, Japanese government debt levels have risen significantly and there may be a desire to raise taxes to help reduce the debt burden. This has proved an unpopular policy for Abe in the past and a new prime minister will struggle to make any significant tax changes while Japan recovers from Covid 19.
The Japanese yen is likely to be strong against a weak US dollar but should lag other Asian currencies while there is a leadership vacuum.
Taku Arai, deputy head of Japanese equities
Schroder Investment Management (Japan)
The LDP [Liberal Democratic Party of Japan] election is now set for September 14, and it is likely that Shinzo Abe's successor will be Yoshihide Suga. Should that be the case, there'll be no change to policy directions including fiscal and monetary policies.
The appetite that foreign investors have for Japanese equities has been low. We have seen a lot of outflow from the market from these investors since last year because of Japan's cyclical downturn and the fact that valuations haven't been attractive enough.
That has also escalated because of Covid-19, but we are finally seeing the market turnaround as investors start to bet on cyclical recovery both globally and in Japan. We are beginning to see some inflows into the Japanese equity market from global investors again. Assuming that there will be no surprises in the LDP leadership election, we don't really think that Abe's resignation is fundamentally negative to the appeal of investing in Japanese equities.
The new Japanese government, however, will face challenges such as US-China tensions, which Abe has been handling well in terms of maintaining his relationships with the country leaders. These external factors might impact investor sentiment on Japanese equities while we still see fundamental positives including earnings recovery and the strong balance sheet of Japanese companies.
Kwok Chern-Yeh, head of Japanese equities
Aberdeen Standard Investments
With uncertainties around the political transition ahead, the worry is that Abenomics could soon end.
The Bank of Japan has been running one of the world’s largest asset purchase programmes; a marked change of direction could potentially have large impacts on asset prices. That said, [even though] BoJ governor Haruhiko Kuroda’s term ends in April 2023, a continuity of monetary policy is the most likely outcome. While the Covid shock has probably lowered the equilibrium rate of interest, low yields are likely to persist, even with reduced support from BoJ purchases.
Looking back at Abe’s major reforms, his commitment to corporate governance has been most meaningful for Japanese equity investors.
We expect Japanese equities to remain attractive for investors, as companies’ fundamentals remain intact. The fact is that a rising number of Japanese corporates are now less impacted by domestic economic policies: many have looked abroad for growth, diversifying their operations from a maturing home market.
The health of the global economy and the ability of companies to balance risks and opportunities in their businesses are more important determinants of equity returns – as is the sustainability of improvements in governance.
Shogo Maekawa, global market strategist
JP Morgan Asset Management
Investors are a little concerned about whether Shinzo Abe’s economic friendly policies will continue after his departure, while the market thinks that it will be difficult for the next prime minister to be able to maintain the same degree of political stability as Abe has.
Regardless of who the successor is, however, I don’t see a big change on the economic policy front in the short to medium term, since there is no real alternative to easy fiscal and monetary policy under such a weak economy.
In fact, it is expected that all potential candidates would try to continue the expansionary fiscal policy and accommodative monetary policy for the time being, and Haruhiko Kuroda will remain BoJ governor until April 2023, so there will be no change to monetary policy.
Nevertheless, many market participants are interested in whether the Abenomics line will be followed or corrected from a long-term perspective. As for now, financial markets would welcome the former. If it looks increasingly likely that the next prime minister will continue the current macroeconomic policies, the impact on Japanese stocks, bonds, and currency markets would be limited.
Paul Parascandalo, multi-asset fund manager
The lingering effects of the Covid-19 crisis are likely to ensure that we will not depart too much from the status quo in Japanese monetary and fiscal policy over the next six to 12 months. It is likely that the BoJ will have no option but to continue to finance a large fiscal deficit, a situation in which many central banks and governments across the world will also find themselves.
Two of the main candidates to succeed prime minister Abe, Suga and Kishida, have been long-time supporters of Abenomics, and governor Kuroda, whose term ends in 2023, should provide continuity from a monetary policy perspective.
Uncertainty around who will become the next LDP president, and hence the nation’s prime minister, may lead to some very short-term investor caution on Japanese assets. Over a slightly longer time horizon, external factors like the pandemic and its impact on the global macro environment will provide much greater challenges for the internationally exposed Japanese stock market.
This article was updated to clarify Jason Liu's job title.