Japanese Prime Minister Abe’s Shock Resignation Will Mean Volatility And Buying Opportunities

Political uncertainty has been an increasingly distant memory for Japanese equity investors, but it came back unexpectedly today after prime minister Shinzo Abe’s shock resignation for health reasons.

The country’s benchmark Topix index fell by as much as 1.6% on the news, before recovering slightly to finish down 0.7%. The yen rose over 1% against the dollar as investors piled into the currency, perceived a safe haven at times of panic.

Japanese equities look set to be in for a bumpy ride over the next few months as the ruling Liberal Democratic Party (LDP) selects a successor to Abe, the country’s longest-ever serving prime minister.

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The key question for investors is whether the new premier will continue the flagship economic reforms seen as so intertwined with Abe’s rule, that they even carry his name: “Abenomics”. The consensus is a resounding yes with investors being advised to buy into any stock market dips while the new leader is chosen.

“Abe’s departure shouldn’t be seen as a giant wobble,” said Eva Sun-Wai, a fund manager at M&G Investments. “We expect relatively higher volatility for a while as Japan goes through this transition phase..[but] this is a good entry point rather than a reason to worry.”

Abe came to power for the second time in 2012, introducing his “three arrows” of economic reform: aggressive monetary easing, increased government spending, and an overhaul of corporate governance.

The ambitious program was designed to make the country both more competitive and more attractive to foreign investment. The corporate governance reforms in particular attracted overseas equity buyers by increasing the focus on capital efficiency and shareholder returns.

Joe Bauernfreund, CEO and chief investment officer of Asset Value Investors, “strongly believes” these will not be swept away by Abe’s successor, having now become entrenched.

“Abe’s program of reforms was radical when it was first established at the start of his premiership. Today it is seen as integral to the success of the Japanese economy,” he said.

The very fact that Abe’s successor will come from the incumbent LDP party makes a significant change of economic policy more unlikely. Abe will remain in charge in the interim.

No candidate is considered a shoo-in for the role. Potential names in the frame include LDP policy supremo Fumio Kishida, chief cabinet secretary Yoshidide Suga and LDP secretary-general Shigeru Ishiba.

Masaki Taketsume, manager of the Schroder Tokyo fund, said: “In reality, since the LDP will remain the dominant party, we would expect little to change. In fact, this may be a good opportunity for a new leader to refresh the cabinet and refocus the pandemic response.

“The next prime minister may bring some differences in the emphasis on various structural reforms but overall we would expect continuity of fiscal policy.”

In many ways, their hands will be tied. Whoever replaces Abe will inherit a difficult economic backdrop. For all of the positives of Abenomics, it was unable to lift Japan out of its 22-year deflationary cycle.

The impact of the coronavirus pandemic will provide a further constraint. Japanese GDP fell by a record 27.8% in the second quarter as the lockdown collapsed corporate profits and sparked a slump in consumer spending.

The government announced a ¥117 trillion ($1.1 trillion) economic stimulus package in April. Although the administration has been lauded for its economic response to Covid-19, Abe’s popularity had been waning recently as infection rates started to climb again, albeit from a very low base compared to other major economies.

One bright spot has been Japan’s rude corporate health, characterized by low debt levels and the recovery in earnings beating expectations.

Taketsume said anecdotally, Schroders estimates around 40% of companies beat market expectations, with 40% in line and 20% underperforming.

“This compares to a more typical split of roughly one third in each category,” he said.

Archibald Ciganer, who runs the T. Rowe Price Japanese Equity fund, makes the country’s case as an “under-owned” portfolio diversifier for investors.

“With corporate Japan evidencing little to no net debt, and with corporate governance continuing to improve – even as profits have been pressured – Japan provides a very different set of characteristics to US equities, which have led the strong equity market rally in recent months,” he said.

The Topix is down 6.77% year to date, having recovered most of the losses suffered in the March global equity sell-off, but lags the S&P 500’s 8.38% gain. Japanese equities are certainly not cheap, but, any sell-offs in the coming months could throw up buying opportunities for long-term investors.

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