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Depreciating yen is no substitute for structural reform

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Simon Somerville (pictured), manager of the Jupiter Japan Income Fund and the Jupiter Japan Select (Sicav) Fund says the magnitude of the yen’s decline should accelerate the turnaround in the Japanese economy but warns a depreciating currency is no substitute for long-term structural reform…

The tumbling yen may be reviving hopes of an export-led recovery for Japan but any sustainable improvement in the economy can only come from long-term structural reform, says Simon Somerville, manager of the Jupiter Japan Income Fund and the Jupiter Japan Select (Sicav) Fund.

With the US dollar now buying more yen than it has done in over four and half  years1, investors have been rushing to buy shares in Japan’s major exporting companies on  expectation that profits and revenue will climb sharply as overseas demand for their products  improve. It is quite likely that we will see Japanese exporters start to revise earnings and sales forecasts upwards over the coming months as the extent of the fall in the yen has, in my view, been much greater than anticipated. The shift in the portfolio towards exporters has been going on for some time. We have brought in new holdings in companies like OSG, a world leader in high-end cutting tools, and watchmaker Casio Computer, a highly profitable company with a good export business.

The yen’s slump is perhaps the most visible result of what has become known as Abenomics – a series of stimulus measures introduced by Prime Minister Shinzo Abe to lift the Japanese economy out of recession and a period of deflation that has lasted nearly 15 years.  When Abe spelled out his economic policy, he famously drew inspiration from a well-known Japanese legend – the story of the three arrows – to illustrate the need for coordinated action on three fronts: monetary, fiscal and structural.

By launching an aggressive monetary policy and boosting government spending, Japan’s prime minister has fired off two of his three arrows. Championing a 2% inflation target, Abe’s tough rhetoric on the economy, both during his election campaign and afterwards ignited the current rally in Japanese stocks.  A stimulus package worth 10.3 trillion yen in January has underpinned it while the Bank of Japan’s massive bond-buying programme announced in April under the stewardship of Haruhiko Kuroda has prolonged it. Add to the mix, a series of tax breaks to boost wage growth and employment and you have all the ingredients that have propelled the benchmark Topix Index to its highest level since September 2008.

The rally is underpinned by increasing evidence Abe’s policies are having their desired effect. Household spending, for instance, rose at its fastest pace in nine years in March3 and tax-breaks aimed at encouraging companies to raise salaries should help sustain sales. That’s certainly the view of companies we met on a recent trip to Japan. Consumer products firms like cosmetics maker Pola Orbis, retailer Cocokara Fine and shopping centre developer and operator Aeon Mall all told us they were  anticipating benefits from consumption spurred by wage growth. Japanese firms certainly seem to be heeding Abe’s call for higher wages. High profile wage increases have already been announced at retailers Seven & I, FamilyMart and Lawson as well as manufacturers Mitsubishi Heavy, and Toyota. Summer bonuses meanwhile are also reportedly on the rise, up on average more than 5%, which would represent the biggest increase in nearly a decade.

The hunt for yield is a further consequence of the new measures brought in by Abe. With yields on Japanese government bonds effectively capped by the Bank of Japan’s massive monetary stimulus scheme, domestic investors will increasingly have to look elsewhere for a decent income stream. To capture that trend, we have bought shares in high-yielding trading company Sumitomo Corp while increasing our stake in mobile phone network provider NTT DoCoMo.

Further gains for the Japanese stock market now lie in Abe’s ability to fire the third arrow of structural reform. Specific policies have yet to be announced but the key areas of focus are likely to be increased labour market flexibility, greater female and senior labour participation, trade liberalisation through membership of the Trans-Pacific Partnership and the creation of “national champions” through the relaxation of competition laws. If these structural reforms are even partially successful, it is not only individual companies that will profit but the entire domestic economy.

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