New policies set stage for stronger economy

Policy measures taken by prime minister Shinzo Abe’s government coalition have played a significant role in creating a positive economic backdrop, but it is foremost the changes in corporate behaviour and the improving earnings outlook that have been affecting the assessment of Japanese equities.

It has been encouraging to see how quickly Mr Abe implemented policies in the two weeks following his victory in last December’s snap election. These measures included a ¥3.5trn stimulus package that focused on the majority of households and small- to mid-sized companies that had yet to experience any benefits from Abenomics.

It is worth noting that the supplementary budget will not be financed by additional Japanese government bond issuances, but by better-than-expected tax revenues, particularly from the corporate sector. Furthermore, the initial full-year budget for 2015 shows the quota of issuance to revenues falling below 40 per cent for the first time in six years.

The positive policy backdrop is a necessary but not sufficient reason to be positive on Japanese equities. What is currently more relevant is the performance of the corporate sector. It is encouraging to finally see progress in improving corporate governance, which for a long time has been the weak spot of Japanese companies. The new corporate governance code will be implemented in June 2015, just before the shareholder meeting season gets underway, and will force managers to focus more on shareholders’ needs.

Boards, which will now have to include at least two external directors, will also have to set earnings and capital-efficiency targets. Furthermore, institutional investors will be required to increase corporate scrutiny by engaging in more dialogue with the companies they invest in.

At this early stage, both investors and companies may just try to tick the boxes of the new code. Over time though, these new challenges will indeed improve shareholder value and return on equity (RoE) of Japanese companies, which has hovered far below major global markets for too many years. Progress is already visible. RoE may enter record-high double-digit territory this year, coming closer to the 11-12 per cent range that European and Asian (ex Japan) companies achieve, although still far away from the roughly 15 per cent RoE that US companies deliver.

This gap is reflected in the lower price-to-book valuation of 1.3x in Japan. On this measure, US companies with a price-to-book of 2.5x are almost twice as expensive as their Japanese counterparts.

Demand for Japanese equities hinges not only on strong foreign appetite. Domestic pension funds have become more supportive following the decision of the Government Pension Investment Fund – the world’s biggest pension fund – to increase the share of equity holdings versus Japanese government bonds. Support should also kick in from individual investors, as measures have been taken to increase the appeal of the tax-privileged Nippon Individual Savings Accounts.

That said, although foreign investors have a positive view towards Japanese stocks, there is still a lingering degree of scepticism over the reforms.

Guy Miller is chief market strategist at Zurich Insurance

Japan monetary policy

Guy Miller explains why the policies from the Bank of Japan (BoJ) to maintain a 2 per cent-inflation target are “encouraging”:

“Though the BoJ has cut its inflation forecast for this year, it believes the growth impetus from lower oil prices will lead to higher inflation expectations next year.

“The fact that the dovish Yutaka Harada, a professor at Waseda University, has been appointed to the BoJ board indicates that more quantitative easing is likely to be announced in the months ahead. The range of assets purchased may also be expanded to include regional bonds and perhaps even real estate funds.”