The below graph reflects the significant outperformance of Japanese equities over Chinese and Korean equities since November 2012, coinciding with the election of Japan’s new Prime Minister, Shinzo Abe. Prime Minister Abe, in conjunction with Bank of Japan Governor Haruhiko Kuroda, has embarked on a new policy offensive to raise the Japanese economy from its 22-year deflationary slump.
This new initiative, dubbed “Abenomics,” aims to end deflation by targeting a 2% rate of inflation, as well as to increase fiscal spending by 2% of gross domestic product (GDP). This level of government spending is expected raise the 2013 deficit to a whopping 11.5% of GDP in 2013. This is a greater budget deficit than the United States ran post–2008 crisis, reaching 10% of U.S. GDP during 2009–2010, though the U.S. federal deficit has more recently shrunk to nearly 4% of U.S. GDP. For further discussion of “Abenomics,” note the associated series on Japanese exports and imports, Are we seeing an Abenomics-led recovery in Japan?”
“Abenomics” putting an end to Japan’s deflation?
Japan’s core Consumer Price Index (CPI), which excludes food and energy, had turned into the negative zone as of September 1998, and reached the lowest reading of -1.6% in May of 2010, reflecting the increasing severity of ongoing price deflation in Japan. Though core CPI managed to just barely stay in positive territory in early 2008, the global financial crisis drove core CPI to its 2010 lows. Prior to the collapse of Japan’s “bubble economy” in 1990, core CPI had been at 3%, while total CPI had been at 4%. Core CPI has since risen from the -1.5% level in September 2010, reaching -1.0% post-election and a mere -0.2% currently. Total CPI has risen from 2009 lows of -2.5% to +0.2. This trend reflects that significant improvement in Japan’s progress is slaying deflation. The weakening currency should support this trend going forward, as a weakening currency tends to increase inflationary economic pressures.
“Abenomics” putting an end to the post-1980 era of the strengthening yen?
As a result of the Abenomics policy measures, the Japanese yen has weakened drastically against the U.S. dollar, moving from 76 yen per dollar at election time to nearly 100 yen per dollar currently. A whopping 33% depreciation of the yen took place within six months. This weakening of the yen is dramatically improving profit margins for Japanese exporters despite sluggish growth in total export volumes.
The effect of the weakening yen on Japanese shares reflects above in the relative performance of the Japanese ETFs Wisdom Tree Japan Hedged (DXJ) and iShares MSCI Japan (EWJ). DXJ has outperformed EWJ because DXJ is a dollar-denominated ETF, while EWJ is denominated in the weakening yen. So the outperformance of DXJ over EWJ reflects the additional boost of the dollar’s appreciation over the yen during this period, which is captured by the currency-hedged DXJ, though forfeited in the case of the “unhedged” EWJ.
Meanwhile, Korean and Chinese Equities, as noted above with iShares MSCI South Korea Capped Index Fund (EWY) and iShares FTSE China 25 Index Fund (FXI), have remained soft. This weakness in EWY and FXI are a result of various factors, including the growing competitiveness of Japanese exports amid slow global growth, as well as by muted consumption growth in the United States and European Union. Plus, wages in Japan have remained stagnant, while wages in China and Korea have grown rapidly. In short, thanks to “Abenomics” and a weaker yen, Japanese equities have risen and have also outperformed both U.S. and E.U. equities and avoided the fate of Chinese, Korean, and emerging market shares. For further explanation of the rapid increase in wages in China, see our series on China’s exports and imports, China’s wage inflation: Bad news for corporate profits and banks.”
The Korean yuan has strengthened nearly 22% versus the Japanese yen over the last 12 months, while the Chinese yuan has strengthened nearly 30% against the Japanese yen. Given these large changes in exchange rates, both Korean and Chinese equities have underperformed Japanese equities. Both the Korean Kospi Index and the Chinese Shanghai Index are largely unchanged over the past year. The Korean flagship Samsung (21.7% of ETY) remains largely unchanged since “Abenomics” began in late 2012, while Sony (0.83% of EWJ and 0.72% of DXJ) has more than doubled, rising from 800 yen per share at election time to 2,000 yen currently, peaking at 2,400 yen per share in May this year.
While global equity markets may continue to experience weakness and volatility as a result of these developments, Japan’s policy of “Abenomics,” to include monetary and fiscal expansion, has helped Japanese equity markets outperform Chinese, Korean, and many other global markets, as described by EWJ in the above graph. Plus, should Japan’s policies continue to weaken the yen, thereby providing further pricing advantages to Japanese exporters, you may wish to consider DXJ rather than EWJ as a Japan-specific investment vehicle, as DXJ is denominated in the U.S. dollar, while the EWJ is denominated in yen. Also, investors will need to monitor the ongoing impact of “Abenomics” on Japan’s domestic economy, as further progress of Japan’s monetary and fiscal policies may lead to an ongoing out-performance of Japanese equity markets vis-à-vis Chinese and Korean equity markets.
For further analysis of how China is being affected by Japan and “Abenomics,” please see China’s exports: Is the golden age of cheap labor coming to an end? For further analysis of how United States–related consumption trends could impact Japan’s “Abenomics”-led recovery, please see U.S. consumer spending: Sustaining the unsustainable? For further analysis of how exports are being affected by “Abenomics,” please see Japanese exports: Are we seeing an “Abenomics”-led recovery in Japan?