The fixed investment recovery needs further yen weakness to continue
The below graph reflects the strong recovery in Japanese corporate operating profits post-2008 (the yellow line at the bottom), which are at about 16 trillion yen. Like the USA, Japan is once again seeing record corporate profit levels. Plus, fixed asset investment (the blue line up top) reflects a very large recovery since the new Prime Minister was elected at the end of 2012. As a percentage of corporate profits (the red line), we see that fixed investments as a percentage of corporate profits are at post-1998 peak levels, suggesting that there’s plenty of room for more investment and perhaps wage growth in Japan. This is a very encouraging trend for Japanese equity market investors.
Is capital on strike in Japan?
Hardly! In Japan, capital has simply been asleep since 1990 and largely too overwhelmed with survival to organize a strike. Japan’s corporate profits–to–fixed investment ratio stands in stark contrast to the USA, where the record $2 trillion in corporate profits stand at over 80% of fixed investment. That would definitely qualify for “capital on strike” status, as pointed out by CNBC commentator Larry Kudlow. While the recent pop upward in the above data is encouraging, soft global economic data has left Japanese corporations a little hesitant to build new factories any time soon. However, if the Japanese yen continues to weaken against the yuan at the same pace as in 2014, we have to begin to ponder the possibility of a Toyota car factory being built in Toyoda, Japan, once again.
Abe’s three arrows
- Fiscal Policy: A record budget for 2014–2015, with 9% to 10% deficit-to-GDP
- Monetary policy: The Bank of Japan deposits a rise from 37 trillion Yen late 2012 to an estimated 270 trillion yen by the end of 2014 (growth in the monetary base at the Bank of Japan from roughly $370 billion to $2.7 trillion US dollars—45% of Japan’s GDP); Japan’s monetary base grew 34.4% in 2013 versus 7.0% in 2012
- Structural Reform:
- Consumption tax rose from 5% to 8% on April 1, 2014 (not an April fool’s joke after all), and is slated to rise to 10% on October 1, 2015
- Corporate tax rates are to be cut from 40.00% in 2012, to 38.01% in 2014 and 35.64% in 2015 and thereafter
- Land use reform: Phasing out a 700% tariff on domestically produced rice and using land more efficiently
- Labor reform: Encouraging women in the workforce
- Capital: Urging business leaders to take advantage of the weak yen, higher corporate profits, and investing
Abe has executed on fiscal and monetary policy since 2013, and the Japanese yen has weakened from the 75 highs against the U.S. dollar to around 103 today. Corporate profits, as noted above, have recovered handsomely. Now, Abe needs Japan’s corporate leaders to take a leap of faith and invest. This last part will be challenging. It’s one thing for the government to run large deficits and invest or spend taxpayer money during soft global economic conditions. It’s another matter for private enterprises to take larger risks with their shareholders’ and banks’ capital. Japan’s corporations are clearly concerned with global deflation as the Euro-zone struggles to get inflation over 1.0% and China continues to invest heavily in production.
To see how corporate liquidity, low interest rates, and eager lenders could support further economic recovery in Japan, please see the next article in this series.
Japan’s equity outlook
As 2014 progresses, investors could see a continued outperformance of the 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). For further clarification as to why DXJ could outperform both EWJ and other Asian equity indices, please see Why Japanese ETFs outperform Chinese and Korean ETFs on “Abenomics.” Plus, as Japan pursues unprecedented monetary expansion and the U.S. Fed tapers its bond purchases, Japanese equities could also outperform 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).