On 11 October, the Japanese Nikkei index closed at its highest level since December 1996 and has continued to rise.. Earlier this year, nominal GDP surpassed its level of 1997, marking the beginning of the end of a multi-decade-long period of deflation.
Candriam has been overweight Japanese equities since last July. Beyond an interesting technical set-up, there are three fundamental reasons comforting our asset allocation conviction.
First, we expect the outcome of the general election to validate Shinzo Abe’s mandate. The Japanese prime minister is expected to continue the reform programme initiated in 2013 after the snap election. Clearly, he has turned geopolitical risks into a domestic opportunity as his approval ratings have recovered after a cabinet reshuffle in early August in a context of rising tensions with North Korea. His success would undoubtedly lengthen the visibility of Abenomics. During the campaign, he mentioned that he wanted to win support for the redirection of funds raised from a consumption-tax increase. As he has postponed the consumption tax hike twice already, it will be interesting to see whether he will follow through with the scheduled VAT hike in October 2019.
Economic growth is outpacing potential growth thanks to solid domestic demand and a robust global growth environment. This has already led to a profit recovery over the past twelve months. In addition, as the BoJ is unlikely to join other central banks in removing monetary accommodation in the foreseeable future, this should ultimately lead to a weaker yen and strengthen the attractiveness of Japanese products further.
While the “profit party” has already started, few foreign investors have as yet joined in. Historically, rising Japanese stock prices have been associated with rising foreign equity inflows. After a massive drain of net outflows since mid-2015, non-residents have never really come back, missing the corporate profit recovery underway. We note, however, that the tide might have started to turn as the past two weeks have seen the strongest inflows registered in recent history.