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Three arrows: Assessing the legacy of Shinzo Abe

Date: 22 July 2022

Following the sad news of Abe’s assassination, in today’s Fund buyer we reflect on the former Japanese prime minister’s legacy, as well as looking forward to consider Japan’s future prospects.

After the sad recent news of former prime minister Abe’s assassination in Japan, I want to use today’s podcast to reflect on his legacy, as well as look forward and consider Japan’s prospects from here. Abe came to power for the second time in 2012 and remained prime minister until he stepped back in 2020. That in itself is somewhat remarkable if you consider the ever-revolving door of that office in prior decades. Indeed, Abe was the longest serving Japanese prime minister in history and will be remembered as a true global leader.

He is best known for his three arrows policy, which gained the moniker of Abenomics. The three arrows in question were loose monetary policy, fiscal stimulus, and structural economic reforms. On a practical level, that meant a swift and significant devaluation of the yen in 2012. It also has seen Japan remain as one of the very few countries continuing with quantitative easing today. The more recent policy of yield curve control, pinning 10-year yields to zero, has resulted in another phase of significant yen depreciation as other nations, notably the US, see their bond yields move up rapidly.

Among the structural reforms, corporate governance reforms stand out as a notable success, although some remain very much still a work in progress. The often flabby balance sheets of corporate Japan, with high cash levels, and cross shareholdings routinely in evidence, have been steadily improved. This is reflected in a much improved level of return on equity, or ROE, which historically lagged far behind Europe or US. Again, there is further to go, but the gap has narrowed.

’Womenomics’, or the effort to raise female participation in the workforce, was another successful policy, at least in terms of the raw numbers.

Japan now has a higher participation rate than the US and the OECD average. That said, senior positions still seem largely out of reach for many women, with greater participation in lower paid roles.

Unfortunately, not all aims have been achieved, and perhaps the quest to induce some level of inflation and wage rises has been the biggest shortcoming. The long-term aim of reaching 2% had remained stubbornly out of reach until very recently, when it went above 2% in May.

So, what are the prospects for Japan going forwards, and what might we expect? Judging from foreign investor appetite to invest in Japan, not much. The current level of foreign investor holdings in Japanese equities is back to pre-Abe levels, although this has always been a classic contra-indicator. More encouragingly, foreign direct investment has been rising. The Japanese domestic investor has also been adding steadily to exposure over time and is now in aggregate at its highest level in more than 15 years.

For foreign investors, the depreciation of the Yen has not been helpful to asset returns

The current debate in the short term is how long Japan will retain yield curve control, and with it a persistent depreciation of the yen. Should exchange rates stay at these levels for some time, corporate earnings will likely receive a boost, although Japan is more susceptible to a global slowdown than most given its export driven economy.  For foreign investors, the depreciation of the Yen has not been helpful to asset returns, so any suggestion of a snap back if yield curve controls are removed might provide a short-term boost.

Another shorter-term consideration is the recovery from Covid-19. Japan has taken longer to exit restrictions than many in the west, and so is still more in the recovery phase, as evidenced by the fact that it is the only major economy forecast to grow faster in 2022 than 2021, according to the IMF. It is also somewhat more reliant on China than most, who are also still in the throes of attempting to exit restrictions.

Politics is also worth dwelling on. Abe was not in frontline politics, but he remained hugely influential as a power broker and was still the LDP party leader. As such he continued to provide policy direction and a guide to current prime minister Kishida. It may be that Kishida feels more able to move on from some policies going forward. The very recent upper house elections saw the ruling LDP, Kishida’s party, achieve a landslide victory. He is known to be more hawkish than Abe, so perhaps the chances of tighter monetary policy have increased. It may simply be luck, but Kishida may also preside over the first bout of real inflation for many years, and the prospect of finally inducing some wage inflation in the economy, a key aim of Abe. Not all would agree though and speaking to one manager based in Japan very recently, he noted that whilst his lunchtime noodle soup had now moved up in price, there appeared to be little else that he had observed increasing in his daily life.

Lastly, what of corporate governance? There continues to be a steady stream of unfortunate headlines made by larger companies that would suggest that this is an area that is not improving, but Japanese equity managers I speak to have a more positive view when looking at the bigger picture.

Apart from corporate governance, much of what I have talked about today is shorter term in nature – Covid-19 recovery, potentially tighter monetary policy and so on. With a much longer-term view, Japan continues to trade at a reasonable valuation and offer access to exceptional global leading companies, notably in growth areas such as robotics and automation. The conversation around ESG is also interesting, with many smaller companies scoring poorly with ESG datasets, but often primarily due to poor disclosure on systems requiring English. There is a mini-industry within asset management today that has seen this as an opportunity, and one might see Japan as a country that will undergo significant improvement with less effort than elsewhere.

To balance the positives, investors should be aware of the difficult demographics and the ongoing question of whether Japan is truly transforming itself in everything from corporate governance to immigration. Personally, I still see it as having a place in a portfolio, offering diversification and long-term growth to patient investors. Unfortunately, I suspect many will feel they have heard the story before, but perhaps therein lies the opportunity.

That’s it from me today. As ever, thanks for listening and stay safe!

This is a marketing communication and is not independent investment research. Financial Instruments referred to are not subject to a prohibition on dealing ahead of the dissemination of this marketing communication. Any reference to any securities or instruments is not a personal recommendation and it should not be regarded as a solicitation or an offer to buy or sell any securities or instruments mentioned in it.

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