After underperforming earlier in the year, Japanese equities started rising in late August and should maintain strong momentum in the coming months. Over the past month through September 14, the Nikkei 225 Index gained 9.1%, and the iShares MSCI Japan ETF, EWJ, was up 7.8%. In comparison, the ETF that covers all advanced-economy markets outside of North America, the iShares MSCI EAFE ETF, EFA, was almost flat, + 0.2%. Japanese equities continue to appear inexpensive compared to other advanced-economy stocks. Moreover, the Japanese economic outlook is positive despite some easing in foreign demand, continued COVID outbreaks, and the upcoming election.
The Japanese economy’s growth in the recovery quarter, Q2, was solid; and the full-year growth rate for 2021 is projected at 2.4%. Next year, economic growth may be close to 3%, well above the estimated long-term potential rate of less than 1% for this aging economy. Japan has been struggling with a new wave of COVID cases, mainly the Delta variant. Continuing vaccination progress, however, is expected to reduce COVID’s drag on the economy in the remaining months of 2021, leading to renewed growth in consumption. The objective of the government is to vaccinate by November all who are willing to be vaccinated. The expected ending of the state of emergency and reopening will likely lead to increased consumption, since spending has been pent up because of pandemic restrictions and concerns. Investment spending is also recovering. Both consumption and investment will benefit from continued fiscal support. Also, the Bank of Japan’s monetary policy is expected to remain unchanged, with continued monetary stimulus and yield curve control, keeping the benchmark yield on 10-year government bonds at around zero.
There are several factors that present headwinds to exports and the manufacturing sector. The first is a moderation of economic growth in China and South East Asia. Shutdowns due to the fourth wave of COVID have affected growth in these countries. While Japan’s exports have been growing strongly, 25% y/y in July after 32% in June, external demand may be weakening. Second, also because of the pandemic, manufacturing companies have been impacted by severe supply-chain disruptions, according to the August au Jibun Bank Flash Japan Manufacturing Purchasing Managers’ Index (PMI). It is looking as if these disruptions, which are hitting global manufacturing, are likely to take considerably longer than expected to resolve. These developments are having an effect on the mood of Japan’s manufacturers. The Reuters Tankan Index of manufactures’ confidence for September fell to a 5 month low.
It may be surprising that the sudden resignation of Yoshihide Suga as prime minister on September 3 has not had a noticeable effect on markets. The ruling Liberal Democratic Party, the LDP, will select its new leader on September 29. That person will then lead the party in a general election that must be held by November 30. The current leader in the polls, Taro Kono, the current minister in charge of deregulation and vaccination and a former defense minister as well as a former foreign minister, would be expected to bring in a new, younger generation of politicians. He has called for closer ties with the United States. He is a graduate of Georgetown University and spent time as an intern with US Senator Richard Shelby of Alabama. The other leading contender is Fumio Kishida, former LDP policy chief and a former foreign minister. He is seen as the continuity candidate who would be most likely to keep many of the existing team of politicians. We do not expect a significant near-term change in current economic policies as a result of the election, but longer-term policies may well differ.
Cumberland Advisors is maintaining its Japan equity ETF positions in our International and Global Equity ETF Portfolios.
Of the above-mentioned ETFs, Cumberland Advisors currently holds EWJ in its accounts. The writer holds none of them in his personal accounts.
Bill Witherell
Chief Global Economist
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Sources: Financial Times, Oxford Economics, Goldman Sachs Research, HIS Markit, CNBC.com, reuters.com
