Abenomics, Almost By Accident, Just Might Work for Japan Next Year

22-Dec-2016 Intellasia | Realmoney | 6:00 AM Print This Post

The news flow out of Japan does not reflect that the nation, with an economic output of $6.0 trillion per year, remains the third-largest in the world. It’s as if the headline writers are stuck in the 1980s while the economy no longer is.

The Bank of Japan on Tuesday upgraded its view of the country’s economy for next year. “Japan’s economy continues to recover moderately as a trend,” the BOJ stated. That’s a more upbeat perspective than last month, when the central bank warned that slow demand from emerging markets would weigh down exports and output.

Will central-bank chief Haruhiko Kuroda and his brother-in-arms prime minister Shinzo Abe be able to turn that stronger performance into the inflation that they so desperately seek? It could be one of the major surprises of 2017, according to one outspoken economist.

Inflation is also a key factor to consider when watching Japan’s property industry, which now accounts for a record load of bank loans. That could present a structural problem if the property industry develops into a bubble that then bursts.

Japan’s economy grew 1.2 percent in 2015, according to Thomson Reuters, compared with the previous year, and is forecast to have risen 1.0 percent in 2016 and to do so again next year as well. Technical recessions – two straight negative quarters – are common, but under Abenomics, the nation appears to be on slow but steady footing.

It has been aided by a weakening currency. The yen now stands at JPY 118 to the dollar, an 18 percent decline from its low of JPY 99.9 to the greenback this year. The Australian bank Westpac anticipates it will slide further to JPY 124 to the dollar in 2018.

Abenomics is making slow and steady progress. But it could take a leap next year, according to Jesper Koll, the CEO for Japan of the ETF provider WisdomTree and former head of Japan equity research for J.P. Morgan Chase.

BOJ chief Haruhiko Kuroda could actually succeed in his bid to push inflation to 2 percent, Koll says as part of his list of “10 Surprises for Japan” next year. He makes clear his views are far from consensus and designed more than anything to make people, particularly investors, think.

The drive would come from unemployment sinking to 2 percent – not out of the realm of possibility since it has already declined from 4.3 percent to 3 percent. Kuroda would therefore succeed not because of his loose monetary policy but because the nation has reached a world-record low jobless rate.

Inflation and higher interest rates might ease some of the pressure that threatens to create a bubble in Japanese property. The weak yen and the recent rise in commodity prices also push up the cost of the imports necessary for building new houses and apartments at a time when the low jobless rate has not yet fed into higher wages.

Negative interest rates, as they now stand in Japan, are driving investors into real estate and Japanese real-estate investment trusts, as I explained last month. The J-REIT sector is being bolstered by the buying policies of the BOJ, which has identified their shares as a specific target as part of its stock-buying programme.

Higher interest rates from the BOJ, to contend with inflation, would discourage home buying. That’s coupled with existing tightening of loan supervision by the authorities and tougher screening by banks.

Their exposure to the real-estate industry is at an all-time high. At the end of September, they had loaned JPY 69.7 trillion ($590 billion) to property companies, surpassing a long-standing record from the end of Japan’s real-estate bubble in 1999. It leaves banks with 14.8 percent of all loans going to the real-estate sector.

J-REITs have been a prime destination for that lending. They typically buy high-end office buildings in central Tokyo, and have continued to drive those prices up since the properties generate decent yields at a time Japanese interest rates are negative. There’s good evidence, the Royal Institution of Chartered Surveyors says, that the strong flow of money into Japanese commercial real estate has nothing to do with underlying demand and is caused by the negative interest rates – a situation that would change if Koll is correct.

The BOJ has targeted 10-year bond rates and pledged to keep them positive. This, RICS says, amounts to a 25-basis-point increase in mortgage rates for home buyers, an additional disincentive.

So Nomura, which just conducted a series of discussions with investors in Hong Kong and Singapore, recommends turning to home-builders that are diversifying, such as Daiwa House Industry (DWAHY), which is moving into commercial and logistics property. Sekisui House (SKHSY) has a focus on higher-end urban housing, which looks set to remain strong even if mass condo sales continue to weaken.

Japanese real-estate stocks tend to run about six months ahead of any pickup in consumer spending. So if Kuroda and prime minister Shinzo Abe succeed in their bid to stop and Watanabe from saving so much – it doesn’t make sense to buy a new car or fridge during deflation, when prices will be cheaper next month – and encourage them to spend, watch for a run in property shares.

Of course, when discussing Japan, there are really two nations – there’s Tokyo, the Kinki region around Osaka and Kyoto (which isn’t quite as fun as it sounds!), and arguably provincial capitals like Fukuoka. And then there’s the rest of the country. Rural Japan is hurting badly, and the government’s current scheme is to unify towns that are getting hollowed out, with one having the hospital and the neighbour the government offices, for instance.

Tokyo already has its eyes on the Olympics in 2020. Large redevelopment projects and Olympics-related orders are driving the sales of Taisei (TISCY), which is helping build the Olympic stadium. Public-works spending in general has long been a favourite stimulant for the Japanese government, and already makes up around 20 percent of the business of the leading general contractors.

Public works spending is expected to ramp up substantially in 2017, also suggesting pickup in prospects for Kajima (KAJMY), with a construction-order backlog that’s already high and rising. Specialty contractors such as Yokogawa Bridge Holdings T:5911 may well be worth a look as well.

Jefferies is concerned that the real-estate market in Japan will peak in 2017, so it has adopted a cautious stance. On the short side, it targets Sumitomo Realty & Development (SURYY) as its “least preferred developer” thanks to a poor leasing portfolio, mainly in the high-vacancy wards of Shinjuku and Minato in Tokyo, and highly priced shares.

I’ll have an update on the situation in Japan next month – like many people in greater China, the weak yen has made it too attractive to pass up the chance of a cut-rate trip. I’ll be in Hakuba in the Japanese Alps for a bit of snowboarding over the holidays, and still reporting on what I find.



Category: Japan

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