Abenomics on track, says Nikko AM CIO

Ahead of an announcement expected later this month on Japan’s growth reform, Hiroki Tsujimura, chief investment officer of Nikko Asset Management, has argued that Abenomics is on track.

Inflation is climbing, the Bank of Japan (BoJ) is standing firm in its commitment to slay deflation, investor behaviour is changing, and political stability means prime minister Shinzo Abe has the mandate to see through far-reaching changes, noted Tsujimura.

Last year Japanese equities rose 55%, the yen weakened 25% against the dollar and CPI rose to 1.3% in February, he added, speaking at AsianInvestor’s recent Investment Summit in Hong Kong.

He attributed domestic stocks’ year-to-May decline to skepticism among foreign investors, who account for 60% of daily volume and are disappointed with the results of reforms. Last year, foreign investors bought $150 billion of Japanese equities. Year-to-May they have sold $20 billion, said Tsujimura.

Further, a widely expected second round of BoJ easing and new growth policies had yet to materialise, he noted.

However, said Tsujimura: “If you take the opposite position to Abenomics, that would be a big gamble. I believe the key for Abenomics is whether Japan can overcome deflation; I think it can.”

Two issues are crucial if Japan is to turn around its economy, he added: a corporate tax cut and reform of the $1.3 trillion Government Pension Investment Fund (GPIF) – policies that Abe outlined in a speech at the World Economic Forum in Davos this January.

Earlier this month, the prime minister released a draft of new policies. The finalised changes, which Tsujimura said would likely include tax and pension fund reforms, are expected soon.

Japan’s corporation tax is 36%, one of the highest rates in the world. That compares with China’s 25% and Korea’s 24%. “To be competitive, 24% would be good, but that’s a little too aggressive,” said Tsujimura. “It’s likely to be 28% or 29%.”

Lower corporation tax would boost capital expenditure and improve labour conditions and competitiveness, he noted.

Though Tsujimura expects a tax cut to be announced, he said the new rate would likely be decided by November, when deliberation of next year’s budget would begin.

Turning to the second key reform, he said GPIF is likely to alter its allocation mix to align with other countries where inflation is running at 2%, the government’s target.

Some 56% of the GPIF’s assets comprise Japanese government bonds, whose 10-year yield is 0.6%. Domestic equity accounts for 17.2% of the fund’s AUM. “If the domestic equity proportion is increased by 10%, the GPIF would have to buy $120 billion of equities,” he noted.

While tax and pension reform are firmly on the agenda, investor behaviour is also important, Tsujimura said. “After 15 years of deflation, cash is king and mindsets are conservative.”

But that’s changing, albeit slowly. Last year retail investors sold $90 billion of domestic equities, but year-to-May they have bought $15 billion.

Sentiment is turning positive partly because companies with huge piles of cash are starting to return money to investors through increased dividends and share buybacks, said Tsujimura. They are also increasing capital spending.

He cited toolmaker Amada, which last month announced it would return all of its profits to shareholders through dividends and share buybacks.

Attractive valuations are also boosting sentiment, said Tsujimura. “Equities are really undervalued because of skeptical views,” he argued. “Based on corporate earnings forecasts, the current Topix valuation is low.”

He expects strong action from Abe because continued high approval ratings mean the prime minister can tackle vested interests. “With 15 prime ministers in 20 years, politics had done nothing to revive the economy,” said Tsujimura. “If a company experienced the same turnover of CEOs, it’d probably go bust.”