Seven years of Abenomics: where next?

Shinzō Abe became Japans longest-serving prime minster this week prompting a reflection on his three arrows approach and seven-year tenure.

Seven years ago, Shinzō Abe assumed leadership of a country burdened by stagnant economic growth, unfavourable population dynamics and a mountain of debt. He adopted a “three arrows” approach – dubbed Abenomics – to counter these trends, centred on loose monetary policy, fiscal stimulus, and structural reform.

On the first arrow, Japan has certainly managed to leave behind a deeply entrenched deflationary cycle, although inflation is falling short of the Bank of Japan’s 2% target. This has been achieved, in part, by monetary expansion through massive bond and equity purchases – commonly known as quantitative easing – and the Bank of Japan has said that it will not hesitate to add further stimulus if necessary.

Regarding fiscal stimulus, Japan first hiked the consumption tax five years ago, from 5% to 8%, and followed this with a further increase to 10% in October. In the first instance, the post-increase slump in spending dragged the Japanese economy into recession. However, there are few signs of consumers behaving the same way as they did when the tax went up previously. In addition, the government has exempted items such as fresh food to smooth the impact, as well as introducing alleviation measures for automobiles and housing.

The third arrow of structural reform has contributed to a rise in female participation in the workforce and encouraged businesses to allocate capital more effectively. The productivity of capital has risen, albeit from a low base. Against this backdrop of change, an increasing number of Japanese companies are defying the sceptics by transforming business practices and governance standards. We believe this can help corporate profit growth and generate improving shareholder returns. The volume of shareholder buybacks is increasing, while merger and acquisition activity also shows promise.

The condition of the global economy remains a key factor supporting the Japanese equity market. An environment of modest global growth should continue to help corporate Japan perform well. However, we are concerned about the escalation of the trade war rhetoric coming from Japan’s largest trading partners, China and the US. We continue to hope that sanctions and trade war concerns will subside, but we think that our quality bias in the portfolio should hold us in good stead if trade wars jeopardise the supportive growth environment.

In our T. Rowe Price Japanese Equity Fund, the broad IT and services sector is our largest portfolio overweight, with significant positions in communication names Softbank, Nippon Telegraph & Telecommunications, and NTT Docomo. We are bullish on the industry, specifically the scope for improving earnings, while valuations also look attractive. Elsewhere in the sector, we remain overweight staffing agencies. Signs of a tightening labour market are a key positive for the industry.

Elsewhere, we continue to avoid the banking sector. Intense competition in the sector means that there is an almost unlimited supply of loans at very low rates. Demand is improving for these loans, but they are being offered at the rate of Japanese government bonds in some instances. Net interest margin compression is easing, but the benefits from this are being given up as banks try and gain market share.

Furthermore, with the introduction of negative interest rates on excess holdings and with speculation that this could increase further, the outlook appears challenging for the foreseeable future.

Archibald Ciganer is portfolio manager of the T. Rowe Price Japanese Equity Fund.

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