(July 23, 2013) — Prime Minister Shinzo Abe’s coalition’s landslide victory in the upper house election on July 21 has paved the way for long-lasting economic change in Japan, presenting a buying opportunity ideal for insurer investors, according to JP Morgan Asset Management.
A white paper written by the asset manager has proclaimed that unlike in 2005, where a brief market rally under Prime Minister Junichiro Koizumi saw the TOPIX up 50% in Japanese yen terms before falling again in 2006, Abe’s rally has a real chance of becoming sustainable.
The gaining of power in the upper house of Japanese politics gives Abe a stronger chance of forcing through his policy of growth-economics–dubbed Abenomics by the world’s press–and his commitment to ending deflation.
“Abenomics is arguably the first instance in which monetary and fiscal policy are both sufficiently aggressive to have the potential to end deflation,” wrote report authors Yoshito Sakakibara and Kentaro Sasaki.
“We believe that monetary and fiscal policies are the main tools to increase aggregate demand and promote the closing of the negative output gap. While the growth strategies that make up the so-called ‘third arrow’ of Abenomics are also important, their role lies in maintaining and improving real growth in the longer term, after the end of deflation.”
The first arrow, monetary policy action, was implemented by the new Bank of Japan governor Haruhiko Kuroda in April, setting out concrete steps for the next two years, including doubling the amount of Japanese government bonds purchases and doubling the size of the monetary base.
Accompanied by Kuroda’s commitment to achieve the 2% inflation target in two years, this action has successfully put further downward pressure on the yen, helping to correct the excessive currency strength that arose during the financial crisis.
The second arrow, flexible fiscal policy, saw the Abe government come up with a supplementary budget that included ¥13 trillion of stimulus. This came into effect in February and is now being felt in the economy.
Previous governments have tried to kick-start growth with stimulus packages before, but this time the economy is not in recession and the effect on inflation should be “much more potent”, according to Sakakibara and Sasaki.
The big winners from the Japanese market if it does reach its potential are insurers, specifically life insurance companies.
Margins and solvency for insurers have substantially deteriorated in the last 15 years. Falling interest rates squeezed spreads between guaranteed interest rates for life insurance contracts and interest rate income for life insurers.
Declining asset prices were also detrimental for equity capital positions. However, after the pain of the last two decades, life insurers have completed deleveraging and industry consolidation and are now ready to benefit from the normalisation of interest rates in a reflationary environment.
Banks are also expected to benefit, with reflationary expectations eventually releasing the pent-up corporate and household spending that has built up over the last 15 years of deflation. A gradual but sustainable expansion in bank lending is predicted by the paper.
But there is some bad news: money flows from Japanese institutional investors–mostly pension funds– is expected to be poor.
As a result of the underperformance and the high volatility of recent years, many corporate pension funds are still in the process of reducing equity risk, and converting regional equity allocations to global equity mandates, hitting domestic equity weightings.
The demographics of Japan also play a part, as the ageing population means pension funds are increasingly faced with net outflows, encouraging pension funds to focus more on cash management and liability-driven investment.
Even though Japan’s Government Pension Investment Fund announced that it had raised the domestic equity allocation in its policy mix from 10% to 11% in June, the report’s authors believed any involvement in the market from other Japanese pension funds would be skewed towards the retail sector only.
What to look out for next? The proposed consumption tax. Due to be confirmed or postponed this autumn, the consumption tax is due to increase from the current level of 5% to 8% in April 2014, hitting households hard.
How Abe’s government tackles this tax is crucial, the report’s authors said. Postponing it would help tackle deflation, but the question of whether the tax could still be raised in the future would remain and concerns over Japan’s government debt would grow.
“An alternative would be to use fiscal stimulus to provide a cushion thick enough to absorb the negative damage of the tax rise,” wrote Sakakibara and Sasaki.
“The government is reportedly already discussing subsidies for the housing market. Talk of corporate tax cuts and incentives for capital investment appears to be pointing to another large spending package, which could come into effect in the early months after the tax rise.
“We suspect that the alternative of implementing both the tax hike and the offsetting fiscal stimulus would be the more bullish scenario for the stock market. Under this scenario, confidence in both the economic outlook and public finances would improve, while expectations of falling prices would be likely to be eliminated.”
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