Tuesday, December 18, 2012

Japan's Double Barrel Luck

The Japanese markets have been in the doldrums for the longest, no thanks to the silly yen strengthening phase following the financial crisis as investors somehow still think the yen is a safe haven. The Japanese market has two things going for them this time: the Federal Reserve move which basically tells all that rates will be very low and they will keep printing liquidity into the markets, which negates the need for some to still park money in yen as safe haven; the LDP election victory which propels the markets to a "regenerative phase".

Following is the latest strategy report by Bank America Merrill Lynch on Japan:

LDP victory brings our bullish scenario closer   

With the LDP (294 seats) and Komeito (31 seats) combined (325 seats) now 
controlling a more than two-thirds majority (320) of the Lower House, it now 
appears more likely that the new Shinzo Abe administration will be able to 
exercise strong leadership. Though an LDP victory was widely expected, what 
has not been fully priced into the market is the degree to which the new 
government will be able to put through its legislative program relatively 

Consequently, Shinzo Abe will need to act quickly to implement the policies he 
had set out before the election. Those measures we believe that have yet to be fully factored into the market are inflation targeting, and long-term fiscal 
expansionary measures including corporation tax cuts and a raft of spending 
measures included under the broad title of “national strengthening.”  

As the new cabinet is being drawn up, the focus is now on how and in what order of priority the new administration will put through its policy program, including drawing up a supplementary budget, expanding public works spending, reducing the rate of corporation tax and exercising greater influence over the BoJ’s monetary policy. For instance, if the government moves quickly to put pressure on monetary policy, we can expect the yen to continue to weaken, but if this is put off until after the new BoJ Governor assumes his post (April 2013), then in the near term we could see the market looking to lock in profits. However, at least we can say that waiting for weakness to seek buy-in opportunities is unlikely to be a viable strategy for the time being.  

Cut in corporation tax from 40% to 30% would raise ROE  

A reduction in the corporation tax rate from around 40% to 30% would, we 
calculate, raise TOPIX ROE from 7.8% (FY3/14 IBES consensus) to around 8.9%.  


The next BoJ monetary policy meeting is scheduled for 19-20 December, at 
which additional easing is a possibility. At this point, the market is not expecting explicit inflation targeting to be adopted. On 26-27 December, Shinzo Abe should be officially appointed prime minister at a special Diet session, immediately after which the new cabinet will be announced. Abe has expressed his intention to visit the US in January, so we expect significant diplomatic activity including related to China. From end-January to February we expect a supplementary budget to be unveiled comprising a boost to Apr-Jun GDP and confirming a hike in the rate of consumption tax. In March, two new BoJ Deputy Governors will assume their posts, followed in April by the new BoJ Governor. We expect government and BoJ links to become even stronger, and an increasingly dovish bias in central bank policy.  

When previously elected prime minister in 2006, Abe’s first visits were to China and South Korea to patch up relations that had previously worsened, and this time around we again expect him to take similar practical steps to deal with currently stained relations, though there is a risk of provocative statements being made.  

However, if the cabinet line-up is decided in order to balance factional interests, then the policy program implementation may not be as speedy as the market is hoping. If the cabinet includes a large number of younger politicians, as per the current shadow cabinet, it would strengthen the hand of prime minister, and consequently increase the possibility of the policy program proceeding in line with Abe’s intentions as indicated in speeches etc to-date.  

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