Upside potential: Japanese equity investors could benefit from Abe win

Japan´s Nikkei 225 equity index just clocked up its longest run of consecutive trading-day gains since 1988.

Today marked the thirteenth straight day of gains for the index, with Japan´s leading stock gauge closing 0.4% higher at 21,448.52 points.

Japanese Prime Minister Shinzo Abe has called a snap election for October 22 in a bid to secure four more years of power for his Liberal Democratic party.

Overall, it should be good news for investors in Japanese assets if Abe wins another term as expected.

Economic progress

Increasing Abe´s chances of victory are the recent positive run of Japanese economic data. This has likely been a decisive factor in the move to call an early election; Abe did not have to call an election until December 2018.

The Japanese economy has continued to strengthen this year, with second-quarter economic growth jumping to an annualised 2.5% versus the 1% pace of the first quarter.

Even since Abe called the election, the good news has kept rolling in. In September, data showed industrial production had surged by 2.1% for August.

There are also signs that Japan may have finally exited its long, infamous struggle with deflation.

While still well below the inflation rates being registered across the likes of the US, eurozone and UK, the 0.7% rise in Japanese core inflation reported for August was the highest rate in over two years and the eighth consecutive month of price rises.

For now, the signs are that so-called Abenomics, the stimulatory policies that Abe unleashed to bring Japan´s economy back to life, have been a success.

That said, inflation remains a long way from the Bank of Japan´s (BoJ) 2% target; the central bank maintains interest rates at just 0.1% and 10-year Japanese bond yields capped at 0%.

The BoJ also continues asset purchases to the tune of ¥80tn per year.

Nikkei rally

The Nikkei 225 has surged by around 24% over the past year, making it one of the world´s best-performing stock market gauges in local terms.

Looking at the index´s chart, there was an especially strong leg up in the aftermath of Donald Trump´s win in the US presidential election.

There was also a helping hand from the Federal Reserve (Fed) move to hike interest rates last December and its forecast for three further US rate rises in 2017; the Fed has now delivered two of these promised rate increases.

This was all great news for Japanese exporters, which suddenly received a boost from a sharp rise in the dollar versus the yen.

Yen notes and coins.

Trump factor

Should Trump actually deliver on his election pledges to cut taxes and increase spending, then this should be more good news for the Japanese equity market and its legion of exporting firms.

Higher US growth, should translate into higher US interest rates and with Trump widely expected to plump for a more hawkish successor to outgoing Fed chair Janet Yellen, there could well be further rate rises from the Fed in 2018.

The Fed is also currently expected to deliver at least one further rate rise before the end of 2017.

Weaker yen

At present, the trajectory of US monetary and fiscal policy appears well aligned for further appreciation in the dollar versus the yen.

Over the past year, the Japanese yen has lost around 20% and 8% against the euro and US dollar respectively.

While the dollar has been supported by rising US interest rates, the euro has been boosted by growing momentum across the eurozone economy and expectations that the European Central Bank (ECB) will soon begin to unwind its quantitative easing programme.

Uptight

One interesting feature of Japan´s recent economic data has been the extreme tightness in the domestic labour market; the ratio of job offers to applicants has been running at its highest levels since the early 1970s.

Japanese unemployment is currently at the ultra-low level of 2.8%, down from 4.1% when Abe became prime minister.

Among the top-performing stocks in the Japanese equity market is Keyence, the manufacturer of automatic controlling equipment. The stock has risen by around 50% over the past year.

Aside from being helped by a more favourable exchange rate for its exports, the shares have also been boosted by the increasing automation of Japanese manufacturing processes against the backdrop of the super-tight domestic labour market and a dearth of workers.

Nikkei 225 performance over twelve months.

Good news election?

While the outlook for Japanese equities currently appears good, there are risks on the horizon. In 2019, Japanese consumption tax is meant to rise to 10% from the current 8%.

The Japanese economy may yet need further stimulus if it´s to maintain the current rate of expansion and to ensure a continued steady rise in consumer prices.

Given his willingness to stimulate the domestic economy, this a further reason why a win for Abe in Sunday´s election should be good news for investors in Japanese assets.

By itself, an Abe win is unlikely to lead to much gain for the yen against the dollar or the euro; the ECB looks set to begin curtailing its quantitative easing programme well before the BoJ. We should also soon see the Fed advance its interest rate tightening cycle further.