Japan: Trade or Trend?

by Dr Daniel Murray, chief economist, EFG Asset Management

A change of government and a new central bank governor has led to a new found sense of optimism with regard to Japanese equities. Is this the start of a new trend in Japanese equities, or just another bump in Japan’s long-running downward slope? 

●        The Liberal Democratic Party’s return to power was assured through Prime Minister Shinzou Abe’s insistence on a more aggressive approach to mending the Japanese economy.

●        Abe has followed through with aggressive legislation and the appointment of Haruhiko Kuroda as central bank governor, who has indicated a need to increase the Bank of Japan’s influence on the Japanese economy.

●        One of the government’s goals is to meet a 2% inflation target; a target that, while ambitious, is somewhat unrealistic. EFG models suggest that inflation will turn positive towards the end of this year but will struggle to get much higher than 0.5% year-over-year. 

●        Due to the incredibly high proportion of government debt that is domestically owned (91%), we believe it unlikely that there will be a significant sell off in JGBs despite the low nominal yields offered by the bonds. 

●        Equity markets are likely to continue on their upward trajectory only for as long as there is foreign interest and a weaker yen. Our models suggest a fair value of the yen to be around ¥100:$.

“Absent a meaningful increase in inflation and an associated improvement in structural economic conditions, both which are things we doubt will happen, we believe the recent strong performance in Japanese equities is more of a trade than a trend,” concludes Dr Murray.

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