A dubious economic cure, but Japan QE driving stocks
James Saft on why QE is doing equity investors in Japan a world of good.
QE may or may not be working for Japan’s economy but it sure is doing equity investors there a world of good.
Two years and ¥80trn (US$665bn) into the quantitative easing component of Abenomics, the results for the economy are decidedly mixed: perhaps a 1.5% growth clip in the first quarter and core inflation, stripping out last year’s consumer tax hike, of just 0.2%.
Still Tokyo stocks seems to like it. The MSCI Japan index is up 13.5% year to date in dollar terms, against 2.2% for US stocks, 8% for euro area stocks and 8.1% for emerging markets.
As has been the case elsewhere QE is creating a world investors like the look of, if not a paradise for workers and consumers.
For one thing corporate earnings are running at record levels. With about two thirds of the listed firms on the Tokyo Stock Exchange’s first section having reported, analysts are expecting record profits of more than ¥20trn (US$167bn) for fiscal 2014. Profits are especially strong among electronics manufacturers and automakers, both of which benefit from the weaker yen which is an integral part of the Abenomics strategy.
Strangely, however, Japanese export volumes, the numbers of cars or what have you, are down about 8% since 2012, when now Prime Minister Shenzo Abe’s rise and his enunciation of strategy first sent the currency into a long-term decline. But translated into yen, those lower exports are actually worth about 11% more.
Rather than seizing on a cheaper yen as a means to underprice and win market share, corporate Japan has instead played it safely and profitably. That means fattening margins while sweating existing capital investment. What it does not mean is a boom in either domestic production or domestic capital investment.
Why companies have adopted this strategy is impossible to say. Perhaps they see the weak yen as a passing phenomenon, not something on which to base major investment in new production. Or perhaps their unwillingness to invest in Japan is a reflection of Japan’s gloomy demographic reality. Why not, instead, make investments abroad, both to diversify, and as a hedge against long-term trends in domestic consumption?
At any rate, investors love this kind of thing. Fat margins, and without all the risk inherent in expansion.
Financial engineering in ascendant
Corporate Japan has taken advantage of low rates and capital market funding to get their balance sheets in order, not to mention piling up cash from those record profits. Japanese firms held ¥217trn (US$1.8trn) in cash at the end of last year, a pile equal to about 40% of annual national economic output.
Some of it is finding its way into share buybacks, with ¥3.7trn in buybacks last year, the most since the global financial crisis. That will help to raise returns on equity, which in Japan typically run just above half of those in the US.
Some of the cash is also going to mergers and acquisitions overseas, again hardly a vote of confidence in the prospects for Japan or Abenomics. Thus far this year, Japanese firms have made US$41.8bn in foreign deals, as compared to US$53.4bn for all of 2014, according to Dealogic data.
Companies are also benefiting from something that should be familiar in the US, namely very weak wage growth. Total cash earnings in Japan rose just 0.1% in March and have been, in real terms, declining for two years. Again, this is good for corporate profitability but not great for the economy as a whole.
Just another in the long series of lessons that a country’s stock market is not a very good indicator of its economic health.
As for corporate investment, not only has it been weak, but the most recent Tankan survey by the Bank of Japan shows a gloomy mood among corporations. Big firms plan to cut capital expenditure by 1.2% in the new fiscal year, according to the survey.
The irony, or rather the reward for investors, is that all of this gloomy economic news means that corporate Japan is likely to get a big and increasing dose of more of the same monetary policy. Many analysts expect the BOJ to announce additional QE later this year.
Doing the same thing over and over and hoping for different results may not work for Japan’s economy, but it sure has created a nice ride for investors.
(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication he did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at email@example.com)