By Ichiro Suzuki In December, 2012 Shinzo Abe came back to the office of prime minister after five years, with a bold plan to revitalize the Japanese economy that had been mired in a mild deflation for nearly two decades. His revitalization program was dubbed as ‘Abenomics’ that consisted of ‘three arrows’. The first arrow was aggressive monetary easing through the Bank of Japan’s purchase of government bonds and risk assets such as corporate bonds, equity ETFs and REITs. The second arrow was large scale fiscal stimulus while the third one being structural reform. Of the three arrows, the first arrow, quantitative easing, had the most immediate visible effect through the stock market. The policy shift had turned the Bank of Japan away from its stubborn adherence to a relatively tight monetary policy in the face of an ailing economy. A suddenly ultra easy monetary policy relieved the Japanese yen of a persistent upward bias that exerted a deflationary pressure. The currency had been over-valued because of Japan’s high ‘real interest rates’, causing a downward pressure on prices. (While nominal interest rates in Japan were already near zero, negative price increases, which is deflation, made those skimpy Interest rates attractive adjusted for falling prices.) A change of direction of the exchange rate had immediately altered the outlook on prices. A weaker currency’s effect on export-competitiveness was secondary. The Abenomics rally was much front-loaded in its initial two years. Victims of deflation led the market in early months of the mega-rally. Financials, real estate developers or railway companies that starred in the infamous 1980s bubble were given a new lease on life, surging from very depressed levels, in anticipation of higher asset prices in the economy in general. However, the rally had effectively peaked out by its third summer. Since the summer of 2015, the market drifted sideways essentially. On the day Abe announced he was stepping down, the market (TOPIX) stood at about the same level from five summers ago. The sectors that led the early stage rally eventually faded. Mitsubishi UFJ Bank and Mitsui Fudoson saw their share prices halved over the last five years. Nomura is down 40%. Many others that drove the early stage rally went through the same adjustment process. On the other hand, among export-oriented companies that were supposed to benefit from a weak currency, Toyota is a market performer, remaining at the same level as five summers ago. Sony and Nintendo doubled in their share prices since their businesses are more in line with what’s driving the U.S. tech sector. After all, Corporate Japan’s lack of competitiveness, or weak digital competence, became a drag on stock market performances after initial revaluation of depressed asset prices. There was only so much a renewed macro economic prospects could do to the market. Lack of competitiveness is essentially attributed to the absence of innovation. At a time when the digital economy was storming the society in general, Corporate Japan didn’t have much to offer. There have been serious shortage of disruptive Japanese companies. Since five summers ago when the TOPIX reached where it is today, the S&P500 rose a stunning 80% driven by the dazzling tech sector, led by Facebook, Apple, Amazon, Netflix, Google, Microsoft, Tesla or NVIDIA. For Japan, Sony and Nintendo have some of such qualities, but their effect on the broader market was far from sufficient. There is very little that a prime minister or two can do on the competitiveness of Japanese companies, especially in the technology field. PM Abe drove Corporate Japan hard to enhance their corporate governance. The push has had some visible effects, i.e. in improved return on equity. Nonetheless, such small improvements were dwarfed by these American big techs that are effectively minting money. Another factor that caused Japan’s gross under-performance against the U.S. was financials. Under newly tightened regulations after the global financial crisis (GFC) competitiveness of American banks came to stand out, interns of their solid capital base and management prowess. While they no longer generate return on capital of pre-GFC years, they deliver far superior performances to European and Japanese rivals. In addition to tech, the financials sector also made an material difference on the market performances over the last five years. Even in 2013, the frenzied first year of Abenomics, the S&P500 returned 32%, matching the Japanese market in U.S. dollar terms, as quantitative easing brought a spectacular fall of the yen. As a consolation prize for Abenomics, the Tokyo market delivered a great deal better returns than those in Europe as a region. Europe proved to be a ‘tech wasteland’ with its fragmented banking sector ailing from shortage of capital. In the U.K. and Norway, extraction of fossil fuel accounts for a significant share of the economy. Such an economic structure does not excite investors these days.
About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.