While political uncertainty is plaguing much of the West, Abe has been given a clear mandate to continue Abenomics.
The Liberal Democratic party’s (LDP) convincing election victory on Sunday means that leader Shinzo Abe is on course to be the longest serving Japanese prime minister since the second World War. The LDP and its junior coalition partner Komeito strolled home with 313 seats, meaning they were able to retain their two-thirds ‘supermajority.’
While political uncertainty is plaguing much of the West at the moment, Abe has been given a clear mandate to continue Abenomics and his hard-lined stance on North Korea. An initial challenge by populist party the Party of Hope quickly petered out, though the Party for Constitutional Change did do better than expected, gaining 55 seats. The market has reacted positively to the news, with the Nikkei 225 Index hitting levels last seen over 21 years ago, and the yen weakening against all major currencies. The Nikkei has now posted its longest winning streak (15 sessions) in its nearly 70-year history, and has risen 16.5 per cent over the past six months.
Abe’s election win is significant for two main reasons. First, it paves the way for substantial fiscal stimulus in 2018, whilst maintaining loose monetary policy. Both of these are seen as big positives for the market. Second, it raises the possibility for constitutional reform – specifically Article 9, which was at the centre of the campaign in the lead up to the election. Abe’s aim would be to revise the pacifist legislation that currently forbids Japan from using force to settle international disputes and restricts its land, air and naval forces to a strictly defensive role. His popular handling of the North Korea conflict makes the prospect for constitutional reform increasingly likely.
While it has been largely good news for Japanese equities, the market is still undeniably cheap. Japanese earnings growth has been surprisingly strong, with both EPS and net profits increasing by over 13 per cent and 26 per cent respectively for FY2016 and Q1 FY2017, in turn roughly double and triple consensus expectations. Further, 70 per cent of results beat companies’ own forecasts – a comprehensive and widespread improvement across a range of industries – leading to early and more numerous upwards revisions to FY2017 corporate earnings made by the companies themselves.
The boost in earnings is primarily the lagged effect of the significant fall in oil price feeding through into global GDP growth. This has been particularly noticeable in the emerging markets, a region to which Japanese corporates are significantly more exposed than their OECD peers. This characteristic has underpinned the substantial improvement in corporate profitability, which has further to run based upon the increasing momentum of the current synchronised pick-up in global economic growth. Already one of best value OECD stockmarkets, strong earnings updates have driven the Japanese market’s price-to-equity ratio from 13x to nearer 10x, making it the cheapest across most of the developed and emerging markets.
In summary, Japanese company shares already represent good value, with further gains likely due to rising profitability and continued earnings surprises, and a supportive monetary and political backdrop. The market also continues to see widespread support from local investors’ (including the Bank of Japan) sustained share purchase programs against an increasingly shareholder return focused corporate sector.
Given investors’ current value-based strategic rotation into Europe, we believe Japan could be next in line. Abe’s significant victory could well prove to be the catalyst.
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Chris Taylor is head of Japanese equities at Neptune Investment Management.
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