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Upturn Abe

18 Nov 2013 By Peter Thal Larsen

Say sayonara to the “Bernanke put” and hello to Shinzo Abe’s alternative. While the Federal Reserve chairman developed a reputation for supporting the price of bonds, the Japanese prime minister’s reforms are designed to push up stock prices.

Early enthusiasm for “Abenomics” prompted a hefty rally. Despite treading water in recent months, Japan’s main equity indices are up 55 percent since the prime minister’s electoral victory in December. So far, most of the buying has come from abroad: foreign investors controlled close to 30 percent of the Japanese stock market by value at the end of last year. But there are good reasons to believe that will change.

Start with retail investors. At the end of September, Japanese savers were given the opportunity to register for new tax-free investment accounts, which start in January. More than 3 million have already signed up for the scheme, which allows them to invest up to 1 million yen (about $10,000) a year tax-free.

The numbers could be large: a survey by Nomura Research Institute suggested that as many as 10 percent of eligible investors – equivalent to 10 million people – would open accounts. Assume that all of them put in the maximum permitted, and allocate 23 percent of it to Japanese equities, in line with the current weighting in retail portfolios. In that case, small investors would inject an extra 11.5 trillion yen into the stock market over the next five years, according to Nomura. That’s equivalent to almost 3 percent of the capitalisation of the entire Japanese stock market at the end of October.

The actual amounts may turn out to be smaller. Not all investors will use up their full allocation. And some of the money flowing into tax-free accounts will be siphoned from existing equity investments. Even so, the new accounts look set to rekindle interest in stocks among a population that has grown used to keeping its savings in cash or government bonds.

The same logic applies to Japan’s sleepy pension funds. For years, their response to deflation has been to hoard Japanese government debt. But if inflation picks up, the value of those holdings will take a hit. That’s why an Abe-appointed commission is expected to urge pension funds to increase their allocation to equities when it reports later this month

Once again, the shift could be significant. The giant Government Pension Investment Fund of Japan (GPIF), which has assets of 121 trillion yen, currently has just 15 percent of its portfolio in domestic equities. Lifting that to, say, 25 percent would mean another 12 trillion yen flowing into Japanese stocks. Smaller public funds would be likely to follow suit.

Sheer weight of money alone won’t support stock prices if corporate earnings don’t continue to improve. Though third-quarter earnings at most Japanese companies rose, recent warnings from Sony and Nissan are a reminder that some of Japan’s high-profile corporate names still face strong headwinds.

Yet corporate performance could get an added boost from a new equity index that selects companies according to profitability. That index, due to be launched in January, will select 400 constituents according to criteria including return on equity (ROE). That’s a big shift for Japan, where companies have historically prioritised size over the value they create for shareholders. Nomura’s Japan strategist, Hiromichi Tamura, believes funds like the GPIF may decide to track the new index. That would put pressure on executives to use capital more efficiently

Enthusiasm for the equity market depends on Abe’s reforms. Any sign that Abenomics is faltering will send investors – both domestic and foreign – scurrying back to the safety of bonds. But if that happens, there is another source of support: the Bank of Japan. The central bank is already buying so many government bonds that any plan to boost its asset purchases would probably mean buying equity funds – or even individual stocks. This is not as unthinkable as it may sound: the BOJ is already pumping an extra 1 trillion yen a year into exchange-traded funds. All the signs suggest that the “Abe put” for Japanese shares will be in place for some time to come.


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