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Tuesday, 17 June 2014

Abenomics, Act 2 ?

It seems to me there have been several important developments in Japan in the last few weeks, and in the best traditions of market fatigue and revulsion with a trade that hasn't given people an easy ride for months, they've slipped under the radar. For a start, the markets have lost interest, and what news coverage there is now focusses on investors' disillusionment with Abenomics. Positioning is *much* lighter, and the Nikkei in particular has underperformed this year. 

However :

1. The BoJ is still running the biggest QE programme relative to GDP anywhere, ever. Ok, except for Zimbabwe and the Weimar Republic. It dwarfs the efforts of the Fed and BoE. As inflation picks up real rates are becoming even more negative, so there's a positive feedback of easier financial conditions.

2. The Govt is considering cutting pension payouts by 0.9% annually, regardless of inflation and wages [http://www.bloomberg.com/news/2014-06-17/japan-mulls-de-linking-pensions-from-prices-to-allow-payout-cuts.html]. This is dynamite. First, look at the impact on pension costs : after a decade of this policy they fall by about a tenth in nominal terms, but by OVER A QUARTER IN REAL TERMS - if we can maintain 2% cpi. That does a lot to fix Japan's structural deficit. Second, and arguably more important, is the effect on a typical wealthy Japanese pensioner. They'll face a steady erosion of their state pension income in a "high" inflation environment. What would you do ? They have tons of cash, but deposit accounts now have a negative real return. Unless they want fx risk (and if they do it will boost usdjpy), they have almost no choice but to buy domestic high dividend stocks. 

3. The new Nikkei 400 index futures start trading in November. It's a given that GPIF will benchmark themselves to this index (it's comprised of companies selected for mkt cap, profitability and return on equity). Yucho, Kampo and many private sector funds will follow where GPIF leads. Another tailwind for low p/e, high dividend stocks. Companies are already reacting to get included in the index - e.g. Amada (6113 JP Equity) is up 50% since it announced it will distribute its entire retained earnings in dividends and buybacks solely in order to qualify for inclusion [http://www.bloomberg.com/news/2014-06-10/japan-stock-index-reject-seeks-inclusion-with-100-payout.html]. 

4. The Govt is clearly going to do something to cut corporation tax, most likely from 35% to around 25% over several years. They're still arguing about how to fund it, but assuming they sort that out then it would boost the value of a taxpaying company by 75/65 = 15%. Not such good news for firms sitting on huge deferred tax assets (there's an equity long short trade there), but it's another positive for cheap, low p/e firms. 

5. The NISA account tax breaks have already encouraged private individuals to buy equities, and the Govt is considering whether to double the limits for these accounts. Another incentive for pensioners to buy high dividend shares.

To summarise, the transmission of monetary stimulus (1.) is now being helped by financial reforms (3. and 5.), just as the Third Arrow of structural reforms start to kick in (2. and 4.). Also the spectre of the consumption tax rise has lifted - the world didn't end after all. It looks as though Abenomics is going to start generating some proper traction, at the same time that the street has lightened up enormously on its positioning. The high dividend low p/e stocks are the sweet spot, e.g. banks and trading companies, where P/Es of 6 and dividend yields of 3-4% are available. That seems irresistible/unavoidable for Japanese retail and institutional money. 
We've trodden water for over a year on this now. That's another box ticked for the rally to resume.

The main risk I see is a global equity selloff, especially if the Fed turn out to be behind the curve as the unemployment and inflation numbers are now suggesting. The obvious hedge is either to short US equities or to be short red EDs, but this post is long enough already. I've done both.

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