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Abe’s Third Arrow



Abe’s political gamble appears likely to pay off.

The third arrow of structural reforms continues.

The FSA is continuing to push for shareholder value.

Foreign investors have gone on a three-week buying spree that appears to be the largest in years, and the Nikkei is leading G7 bourses higher this month.


Japan’s Abe’s gamble to call snap elections shortly after the stunning defeat in the Tokyo elections appears likely to pay-off. He called the bluff of his former defense minister and now Governor of Tokyo Koike who is leading the main opposition party now, the Party of Hope. The Party of Hope may have over-reached and now appears to be stumbling. The polls suggest that the LDP may secure more seats in the lower chamber than it a current hold.

Even though the LDP may not need to be in a coalition, it still seems likely that the junior coalition partner, the Komieto Party, will remain in government, even if it loses a few seats. In other countries, this may not be the case, but in Japan, a coalition is helpful in demonstrating the consensus nature of policy and soften the image of the LDP, which has largely governed Japan with only a few exceptions for more more than 60 years.

Recall that when Abe was first elected, Abenomics was presented as three arrows. Fiscal stimulus, monetary stimulus, and structural reform. The first two are tangible. The third is more elusive. It is more elusive not because it is less real or developed, but because the structural reforms are more numerous and may deny an easy soundbite to capture imaginations, the way that greater public investment or quantitative and qualitative easing and targeting yields are easily grasped.

Among the unsung efforts is are corporate governance reform. Recent news of Kobe Steel falsification of the strength of several of its products, used in auto and airplanes, and Nissan’s decision to shut all of its domestic output for the next two weeks as it rebuilds its inspection operations illustrate to many the ongoing needs for greater efforts. Still, these issues seem to involved fraud, which is illegal even before Abenomics.

USD/JPY - US Dollar Japanese Yen, October 20

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USD/JPY - US Dollar Japanese Yen, October 20

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The key institution to watch for corporate reforms is the Financial Services Agency (FSA). It met earlier today. It continued to develop the stewardship, and corporate governance codes and the changes announced a few months ago, regarding asset managers, including disclosure of shareholder specific voting records, and strengthening stewardship of asset owners (including GPIF). What caught our attention were new issues that the FSA identified.

Two of its concerns seem related. The FSA appears to be getting more interested in the “hoarding of cash in internal reserves” and the low management awareness of the cost of capital. It also expressed concern about the slow pace of unwinding cross-shareholdings.

Reports suggest the FSA will develop guidelines to encourage the deployment of the some JPY406 trillion (~$3.6 trillion) on corporate balance sheets. The large cash piles, in the face of weak investment and wage growth, has become politicized in Japan. The Party of Hope, which may be the largest opposition party in Japan, has suggested taxing retained earnings. The FSA does not appear to want to go down this route, recognizing that businesses ought to decide how to use their earnings. Nevertheless, the FSA cited its own surveys that show a clear divide between how companies and shareholders view the cash, and this is of a concern given the emphasis on shareholder value.

The FSA found that 60% of the businesses consider their cash holdings appropriately sized, while more than 80% of the shareholders think the cash is excessive. Retained earnings in Japan have risen by more than 40% over the past five years, according to the FSA. When asked, how the cash should be used, more than 60% of investors favored growth investments. Nearly 1 in 16 agreed with the corporate priority of keeping such large liquidity on hand. Nearly 2/3 of investors did not think businesses satisfactorily explained the size of their cash holdings.

The FSA recognized that the return on equity for Japanese companies has been rising, but it is still low by international comparison. It cited that nearly one in three companies trade less than book value. It also noted that while the large banks have made consistent progress towards unwinding cross-shareholding, non-financial firms have been considerably slower, They detect declining interest and many firms still admit to cross-shareholding accounted for nearly half of their shares.

Foreign investors were net sellers of Japanese shares this year until the last few weeks. MOF weekly data that covered through October 13 showed foreign investors been on a three-week buying spree that was the greatest since at least 2001 when the current time series began. The buying seems to be driven by the decline in the yen, the rise in US yields, and expectations of continuity in Japanese politics. Even though incumbents have been turned out of office, or severely punished, as May and Merkel were in the UK and Germany, Abe and LDP appear to be exceptions. Perhaps the trouncing in Tokyo in July was a catharsis of sorts. The Nikkei is up nearly 5.4% this month. It follows a 3.6% gain in September. The Topix and Nikkei are trading at their best levels in two decades. The domestic buying appears to have primed the pump and also may have encouraged the renewed foreign interest.

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Marc Chandler
He has been covering the global capital markets in one fashion or another for more than 30 years, working at economic consulting firms and global investment banks. After 14 years as the global head of currency strategy for Brown Brothers Harriman, Chandler joined Bannockburn Global Forex, as a managing partner and chief markets strategist as of October 1, 2018.
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