Yoshihide Suga, Japan’s chief cabinet secretary, has been picked as the new leader of the Liberal Democratic Party (LDP). If all goes as assumed, he will become prime minister on 16 September.
Investor expectations for a snap general election could potentially give the market a “Suga high.” Even if that were to happen, however, long-term investors are likely to start subjecting Japan’s fundamentals to a harsh examination, asking themselves whether things really are — finally — going to be different this time.
It is true that there is unlikely to be a dramatic change comparable to the launch of “Abenomics” when the government changed hands in December 2012. However, the event of a new prime minister coming into power for the first time in nearly eight years could itself cause foreign investors to become more interested in Japan. That could trigger buying of Japanese stocks, which are relatively cheap by all sorts of valuation measures.
From the starting point of end-September 2012, when Mr Abe won the LDP presidential election, cumulative net purchases of Japanese cash equities and futures grew to about ¥25tn ($236bn) as of end-June 2015. But intermittent drawdowns from then on turned this into cumulative net sales of about ¥2tn by the end of August 2020. This suggests ample room for purchases of Japanese equities by non-resident investors.
If, in addition to the change of leadership, the lower house were to be dissolved for a snap election, interest in Japan could increase further. The lower house has been dissolved for a general election five times since 2005, and the Topix index has advanced 7.6 per cent, on average, in the period from one trading day prior to the dissolution to five trading days after the election. Over those periods, there were rallies in all five cases and declines in none.
According to a survey by the Asahi newspaper, conducted in early September, the public approval rating for Mr Suga as the next prime minister was 38 per cent, a surprisingly big jump from only 3 per cent in June. The reason, it seems, is that the people of Japan have for the most part accepted Mr Abe’s need to step down for health reasons, and are accordingly throwing their support behind Mr Suga, who has stood by Mr Abe since the very start of his premiership. If a Suga cabinet were to win a high approval rating upon its formation, it is plausible that he dissolves the lower house for the sake of securing a mandate from the population at large.
But what about investors’ hopes for structural reforms? Expectations picked up during the long administration of Junichiro Koizumi (April 2001 to September 2006) and again during Mr Abe’s lengthy second stint in office, from December 2012. Ultimately, though, Japan’s nominal gross domestic product has grown by only 6.6 per cent over the past 20 years, for an annual rate of just 0.3 per cent. Over that span, Japan’s Topix has seen been totally flat, on average, badly trailing the 4 per cent average annual gain made by the S&P 500 in the US.
Japan’s apparently sluggish economic and market performance can be attributed in part to its shrinking population, but the biggest problem is low productivity. It is encouraging that Mr Suga, judging from his recent comments, seems to really understand this persistent problem. However, poor productivity goes beyond the inefficiencies at small and midsized companies that Mr Suga has been highlighting. The average operating profit margin for Topix 500 companies in Japan over the past five years (excluding financials) has been 7.2 per cent, well behind the average 11.5 per cent for S&P 500 companies.
Why the gap? Japan’s unemployment rate stands at just 2.9 per cent despite the ongoing pandemic, astonishingly lower than in other major countries. However, this should also be read as evidence of extreme inflexibility in the labour market, signifying that human resources do not readily flow from businesses with lower profitability into those with higher measures.
Mr Suga’s drive to promote the digital economy should be seen as an extremely important move. Making the strategy work, however, will probably also require making labour laws more flexible and lowering regulatory barriers to entry so that resources can flow to where they can be more productive.
For those companies left behind in the transition to a digital society, a Suga-led administration should provide some support. The world’s long-term investors will be hoping it is not too sweet.
The writer is chief equity strategist at Nomura