Weak yen supports Japan’s automakers’ profits
The below graph reflect the history of the Japanese Yen against major currencies, to include its Asian trading partners of China and Korea. Since 2012, the yen has weakened about 30% against most currencies, and even more so against the Chinese yuan. This article considers the importance of the yen’s continued weakness, which may be required to support Japan’s growth in corporate earnings, as well as the stock market rally.
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Abenomics and the Yen
The initiatives of the new Prime Minister have done much to weaken the Japanese yen, and ignite an equity market rally in 2013. The central bank’s large scale bond buying has added much liquidity to the financial system, and the yen has weakened as a result. Corporate profits have grown dramatically, and investment has shown signs of significant recovery as slack production capacity has finally disappeared. These developments occurred as the Japanese yen weakened from 76 to the U.S. dollar to around 103 at present.
Meanwhile, the Central Bank of Japan expects to repeat in 2014 what it did in 2013, bringing the country’s total assets from 220 trillion yen to 270 trillion yen by the end of this year—that’s roughly $2.0 trillion to $2.7 trillion dollars worth of assets—over 50% of Japan’s total gross domestic product of around 5 trillion yen. In comparison, the U.S. Fed has purchased up to just over $4 trillion in assets/bonds, or roughly 25% of the U.S. GDP. In other words, Japan’s quantitative easing program is about twice as large as the U.S. program relative to the size of its overall economy. That is an aggressive measure that may very well ignite another round of yen selling and growing exporter profits. Plus, the U.S. may end its bond purchases by the end of this year, while Japan has recently announced that it will choose to remain silent on the issue of 2015 plans for now.
Japan’s 2014 consumption tax hike—waiting to see the shake-out
It would appear that the Bank of Japan would first like to see the developments with regard to inflation and economic growth over the course of 2014 before deciding future action. With dramatic consumption taxes rising from 5% to 8% this April, and up to 10% in October, 2015, the Bank of Japan would like to see how the economy pans out first, after the first round of tax changes. Such actions would probably be prudent. The Bank of Japan does not want to inadvertently cause a collapse of the currency, a collapse of Japan bond holdings, and higher interest rates. A 45% of GDP is enough liquidity facilitation for now. The post-2012 pick-up in profits and investment data might be progressing at a good rate, and reflect a good, sustainable trajectory for achieving 3.0% to 4.0% nominal economic growth in an environment of 1.0% to 2.0% inflation.
To see how the inflation adjusted trade data in Japan reflect a growing trade deficit for Japan, move on to the next part.
For an overview of the April 1, Bank of Japan Beige Book on Japan’s economic outlook, read Bank of Japan Tankan supports a 2014 equity rally in Japan.
Japan’s equity outlook
As 2014 progresses, investors could see a continued outperformance of Wisdom Tree Japan Hedged (DXJ) and the iShares MSCI Japan ETF (EWJ) versus China’s iShares FTSE China 25 Index Fund (FXI) and Korea’s iShares MSCI South Korea Capped Index Fund (EWY). Plus, as Japan pursues unprecedented monetary expansion, and the U.S. Fed tapers its bond purchases, Japanese equities could also outperform the broad U.S. equity indices, as reflected in the State Street Global Advisors S&P 500 SPDR (SPY), State Street Global Advisors Dow Jones Index SPDR (DIA), and Blackrock iShares S&P 500 Index (IVV).