Nothing, it seemed, could weaken Japan’s notoriously strong yen for long — not economic weakness, not Japan’s incredibly high debt, not even an earthquake and tsunami. Shinzo Abe, Japan’s new prime minister, has, however, succeeded where all else failed.
The yen has sunk by 11 percent, to 93.80 to the dollar, since Abe’s Liberal Democratic Party won the country’s general election in December; it’s off by 15.1 percent since mid-November, when Abe launched his campaign by demanding that the Bank of Japan print unlimited yen to end the country’s long deflation.
The currency is likely to go on sinking when Abe appoints a replacement to Masaaki Shirakawa, the central bank’s hardline governor, in coming weeks. The prime minister is expected to appoint to the post an advocate of aggressive monetary easing, which could boost growth and weaken the yen. Recent speculation has centered on Haruhiko Kuroda, who, as president of the Asian Development Bank, has urged the BOJ to adopt reflationary policies.
Investors in the struggling export-oriented companies that dominate the Japanese stock market have taken heart. The Nikkei 225 stock index has already leapt 17.1 percent since Abe won the election, and 31.6 percent since he launched his campaign — though much of those gains will have been offset by currency losses for most foreign investors.
Investors differ, however, over whether the biggest prize of all for Japan equity bulls — structural reform of the world’s third-largest economy — is an achievable goal or a perpetual will-o’-the-wisp destined to always recede into the distance.
John Vail, chief strategist at the $154 billion-in-assets Nikko Asset Management in Tokyo, believes the long period of yen strength that pushed the Japanese currency up from a low of 124 yen to the dollar in 2007 is coming to end because of geopolitical reasons and domestic factors.
Outside Japan he says that U.S. policymakers are taking a benignly permissive view of the yen’s depreciation because they want to see a strong Japanese economy as a counterweight to China. Inside the country he sees the Bank of Japan poised for a “once-in-a-generation” change. Largely because of continuing yen weakness, the recent rise in the Nikkei is “the beginning of a bullish trend” likely to unfold over the next few years, he predicts.
“The strong yen has made it genuinely hard for Japanese exporters to compete,” says Vail. “Its depreciation is going to relieve the excessive pain which they’ve been under.” The stock price of Toyota Motor Corp., Japan’s biggest exporter, has surged by 31 percent since Abe’s election victory.
Vail says yen depreciation will also boost domestically focused stocks across the full gamut of sectors by “removing the gigantic cloud of deflation.” He cites the recent sharp rise in bank stocks, which are heavily exposed to the domestic economy. Mizuho Financial Group, one of Japan’s largest banks, is up 50 percent since the election, to 203 yen.
However, some analysts warn that certain domestically focused sectors, such as retailing, could be hit by an increase in import prices caused by the rising yen — mitigating the impact of rising confidence in the Japanese economy as a whole. For example, Yamada Denki Co., Japan’s biggest electronics retailer, is up by a relatively modest 6.4 percent, to 3,430 yen.
Hidehiro Tomioka, senior portfolio manager at $238 billion Manulife Asset Management in Tokyo, forecasts a further “gradual weakening in the yen” because of central bank action. A weak yen would, by his calculations, make a huge difference to corporate profits and hence to equity prices. An average yen rate of 100 to the dollar for the fiscal year beginning April 1 would push average earnings per share for stocks in Topix — a broader equity index than the Nikkei — to 85 yen from 50 yen or so for the current fiscal year. This could send the Topix to as high as 1,500, he says, up 55 percent from its current level of about 967. Tomioka forecasts a broadly similar percentage rise in the Nikkei, which would push that index to 17,700, not far off the 2007 peak. Rises of this order would produce large gains for investors, even in dollar terms.
Skeptics argue that during Abe’s previous term in office, from 2006 to 2007, he proved ineffective at delivering on policy promises. However, Vail says that because of his landslide victory in December, coupled with a desire among the Japanese public to see a weakening of the currency to help end Japan’s economic stagnation, “Abe Mark II is much more powerful than Abe Mark I.”
Philip Poole, global head of macro and investment strategy at HSBC Global Asset Management in London, says the depreciating yen will boost export-focused stocks by giving companies a much-needed boost in competitiveness. “The high level of the yen — which is still overvalued on most measures — has made it hard for Japanese manufacturers to compete with German manufacturers,” he says.
He is, however, more restrained than many investors in extolling the long-term benefits of yen depreciation. He believes that a combination of yen weakness and Abe’s planned fiscal stimulus program will create only “a short-term burst” in Japanese equities. The economic boost from fiscal stimulus “can only last 18 months or two years” before Japan’s high national debt forces an end to it, he contends.
On the other hand, if Abe’s government implements ambitious structural reforms to increase efficiency and productivity, it “could create the possibility of a change from a short-term rally to a longer-term structural increase” in the stock market, Poole argues. Among other things, he cites a need to make it easier for companies to hire and fire workers to improve productivity. Although reform efforts have usually disappointed over the past two decades or so, “what I’m seeing now is a genuine expectation that things are going to improve,” he adds.
Tomioka of Manulife says structural reforms such as greater labor-market flexibility and lower effective corporate tax rates have the potential to boost forward price-earnings ratios from “the low teens” currently to as high as 17. The combination of this and further yen weakness could allow the Nikkei to rise to “16,000 to 17,000,” he estimates. The index closed at 11,398.81 on February 26. Tomioka is, however, doubtful that structural reform will happen, citing powerful vested interests in the country. He joins a large group of investors wary of another false dawn in the land of the rising sun.
