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JP Morgan: Why You Should Buy Jap Equities
Aspire, Hot Picks | 06 May 2015
By: Lim Si Jie
Articles (169) Profile

In October 2014, the Bank of Japan (BoJ) announced an aggressive asset purchase plan that will cover both public sector and private sector assets. While reflation after 20 years of stagnation sounds good on paper, large and sudden currency realignments can cause problems for financial markets.

Japan’s Deflation Woes

JP Morgan cited discouraging facts about Japanese deflation in 2013. Nominal and real growth over the last 20 years were the worst amongst all advanced economies while corporate profits remained stagnant.

Japan’s steady trade and current account surplus since the late 1970s have been dwindling. Government debt to Gross Domestic Product (GDP) was well over 200 percent of GDP, and its weight on the MSCI World equity index fell from 35 percent in 1990 to less than ten percent.

Abenomics To Stimulate Economy

In attempts to solve the issue, a mix of central bank balance sheet expansion and reforms aimed at boosting Japanese productivity was adopted. The slew of policy actions were termed “Abenomics”. The goal was to raise Japanese inflation to two percent, and increase Japanese structural growth by at least two percent.

After some aggressive Quantitative Easing (QE), Japan managed to stimulate the economy enough for inflation. The expectations of inflation rates and durable goods prices budged, rising above zero for the first time in over 15 years.

To keep the momentum going, Japan announced a faster pace of BoJ asset purchases, and doubled strategic allocations for equities in its $1.6 trillion pension fund system. Japanese authorities’ aim was to encourage private sector assets to venture into riskier investments.

Questionable Decision

The Yen has plunged 30 percent since 2012 to generate these results and this raised a number of questions.

  1. Will Japan need a perpetually weaker Yen for Abenomics to work?  What if the inflation experienced by Japan is “cost-push” inflation, which ultimately reduces domestic demand rather than increase it?

  2. What about Japanese materials and service sector companies that cannot pass on higher import costs?

  3. How will the rest of the world respond to further declines in the Yen? China and Korea might fight the weaker Yen by debasing its currency as well.

  4. A weaker Yen is expected to show improvements in export performance. However, why is the export performance not performing as well as it is expected to?

  5. Why is the rise in Japan’s capital spending almost entirely being spent offshore?  As the year came to a close, foreigners were aggressively buying Japanese equities while Japanese retail investors were selling. This was not part of the Abenomics plan.

Unprecedented Experiment

JP Morgan points out that “for the first time in decades, Japan will likely direct its central bank to monetise government debt on a quasi-permanent basis.”  Japan is the first country in modern era to experiment with such methods.

However, if Japan continues to spend, the interest expense would eventually consume a huge portion of Federal tax revenues. Japan would be caught in a dilemma whether to increase its interest rates in hopes of raising its tax revenues. But given Japan’s massive domestic debt, a small increase in interest rates could wreak havoc on its economy.

JP Morgan expects Japanese equities to benefit the most when the government continues to buy private sector assets. But the big question remains: what happens if and when Japans stops buying private sector assets?

Si Jie is no stranger to investing having started his journey at a young age. He is heavily influenced by acclaimed investors such as Benjamin Graham, Peter Lynch, and John Rothchild.

Please click here for more information about this author.

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