Our Opinion: 2016
Deflation makes Japan a buy
Lex in the Financial Times recently reported that “If China wants a lesson in how to shock markets without upsetting them, it could look to its neighbour.”
Japanese stocks bounced by around 3% as the Bank of Japan announced, in January, a reduction in interest rates from 0.1% to -0.1%, thus joining the European, Swiss, Danish and Swedish central banks in negative territory. Japanese banks will now have to pay the central bank 0.1% if they park cash with it.
Only a few weeks before that, the Bank of Japan governor, Haruhiko Kuroda, was adamant that he would not cut rates below zero.
At the time, it was not certain whether this was really a sign of stock market acceptance of the strategy. However, against a challenging background, the Nikkei 225 continues to show a credible performance. Over the last six weeks, it has grown by 12%.
This shock move was Kuroda’s attempt to regain his credibility as a deflation fighter. In the past few months, with China’s slowdown rattling the markets, fears grew that Japanese inflation was looking less and less likely to reach the 2% target. That, in turn, could undermine investment and confidence, making the problem self- fulfilling. The Bank has been forced this year to downgrade its inflation forecast, so it was all the more important that it regain the initiative. That led to Cue Kuroda’s surprise move.
Being charged to hold reserves with the central bank should, in theory, encourage banks to lend it out or invest it instead, spurring growth. But unlike in Europe, the negative rate will apply to new reserves, not existing ones, so there will be little immediate economic impact.
This is primarily a matter of psychology. “As a signal of intent, the move is powerful,” said Adam Cole of RBC Capital Markets. The Bank now has a new tool to fight Japan’s chronic deflation, having already inflated its balance sheet to 75% of Japan’s GDP with its bond purchases through quantitative easing. This is a very big regime change and a clear sign that it will do whatever it takes to create inflation.
Looser monetary policy is not the only reason to like Japanese stocks. Most sectors of the wider market are cheaper than their average valuation since 2000, while firms are more profitable. Earnings have climbed to 3.5% of GDP, double their level of 20 years ago. Japanese firms are sitting on cash mountains, so dividends and share buybacks should rise. Japan also has “everything to gain from cheaper crude”, says Authers in the FT.
Japan remains a buy and this should be reflected in client portfolios.
29th March 2016