Shinzo Abe’s bet paid off. With Japan sinking back into recession and the effectiveness of “Abenomics” called into serious question, the Japanese prime minister called a snap election two years early to secure a governing mandate.
Well, he got it. Shinzo Abe and his coalition partners got 68% of the vote, giving him the political support he needed – and four more years – to push through with his economic reforms. Whether you can really call this a “popular mandate” is open to debate. Only 35% of Japanese voters bothered to show up, showing a remarkable amount of apathy, given how horrendously bad Japan’s economy is.
New data showed that Japan’s recession is even worse than thought. The Japanese economy shrank by an annualized 1.9% last quarter, rather than the 1.6% originally reported. And that drop follows the 7.3% implosion of the second quarter. Effective or not, the election means that Abenomics will be in effect for at least another four years.
Here’s why that victory doesn’t matter.
Japan Has Serious Demographic Problems
I don’t want to rag on Abe, and I’m actually very supportive of his reform agenda. But try as he might, Abe can never be Japan’s Reagan or Thatcher. As sick as Britain and America were before the Reagan and Thatcher revolutions, the problems facing both countries were political. A politician with sufficient charisma (Reagan) or cojones (Thatcher) could have fixed them.
The issues Japan faces are not political; they’re demographic.
Japan is the oldest country in the world with a quarter of its population already over the age of 65. Japan’s population peaked seven years ago at 128 million and hasn’t stopped shrinking since – Japan has about a million fewer citizens every year. By 2060, the Japanese government estimates that Japan’s population will have shrunk to 87 million people, and as much as 40% will be older than 65.
That’s a problem, to say the least. In a modern economy, consumer spending is the dominant contributor to GDP. But consumer spending requires consumers, and Japan has fewer of them every year. And the ones they do have are older and more inclined to save than spend.
Let’s look past consumer spending for a minute. What about real estate? It’s hard to imagine home prices enjoying much of a sustained rise given that there are fewer buyers every year. Given the importance of home equity to household wealth – and given the importance of performing mortgages to the banking system – it’s hard to imagine real estate being anything other than a serious economic drag for decades to come.
And that drag will appear in both commercial and residential real estate. Fewer Japanese citizens also means less demand for office space and retail space.
Nevertheless, Shinzo Abe is making a real effort at spurring growth, as hopeless as it might be. Let’s take a look at what his policies might mean for the yen, for Japanese bonds, and for Japanese stocks.
Japanese Stocks Still in Trouble
Two major planks of Abenomics are aggressive monetary stimulus and increased government spending. Both of these suggest that the yen will continue to sink, particularly versus the dollar. After years of record budget deficits and creative Fed policy, the United States is slowly returning to more “normal” policy, while Japan is moving the other direction with gusto.
Adjusted for the relative sizes of the economies, Japan’s current quantitative easing program is about three times bigger than “QE Infinity” was at its largest.
The yen story is straightforward. Barring the occasional short-covering rally, the yen should continue to fall. But the story with Japanese bonds is far more complex.
Normally, wildly aggressive money printing and deficit spending causes bond yields to rise in anticipation of inflation. Well, Japan has no inflation, and bond yields are kept low by the aggressive buying by the Bank of Japan. The Bank of Japan is, for all intents and purposes, buying bonds faster than the treasury can print them.
That speedy buying means that Japanese bond yields should stay near record lows for now … though I eventually see yields soaring to unpayable levels when the yen’s orderly decline turns into a rout.
What about Japanese stocks? The iShares MSCI Japan ETF (NYSEARCA:EWJ) has been quiet of late, trading in a relatively tight trading band since May of last year. And this is not simply a case of stock gains being offset by currency losses; the WisdomTree Japan Hedged Equity ETF (NYSEARCA:DXJ), which hedges its exposure to the yen, has had a fantastic run over the past two months. But its year -to-date returns have been nothing special, underperforming the S&P 500.
The deteriorating economic picture appears to be roughly balanced by quantitative easing. Unlike American quantitative easing- which was exclusively the purchases of government bonds and mortgage securities – the aggressive Japanese variety includes purchases of Japanese ETFs.
Normally, I prefer to be on the same side of a trade as the central bank. They have more money than I do, seeing as how they can print money at will. But in this case, I essentially see a transfer of ownership. Disillusioned Japanese and foreign investors are selling their shares to the Bank of Japan and reinvesting their funds elsewhere.
I don’t expect much of a rally from EWJ or from Japanese stocks in general. If you want to wager on Japan, stick with shorting the yen.
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