Abeconomics and tapering: investment implications
by George Hatjoullis
The Federal Reserve of the USA will soon initiate a tapering of its QE programme, quite possibly as early as 18 September. The US equity market has yet to fully digest this event and will likely experience a correction around the event. Once the market realises that the Fed is not incompetent and that economic activity is holding up well, the upward trend will most likely resume.
The Japanese market has already corrected quite sharply, the catalyst being the prospect of tapering and a slowdown in the China economy. The S&P 500 has since made new all time highs but the Nikkei has yet to regain the previous highs of even this year. Yet it is the Abe government that is proceeding with an economic strategy designed to break the structurally negative inflation expectations. This strategy has a long way to run and is unambiguously positive for Japan equities. The implications are that the Nikkei should outperform the S&P 500 over the next year or so.
The mechanism of outperformance is, in part, dollar yen. The relative shift in monetary policies favours a continued rally in dollar yen. The interim target is 106 but it could always overshoot. It usually does. The Nikkei in particular is very sensitive to dollar yen and a resumption in yen depreciation will boost Nikkei whatever the S&P 500 is doing.
The caveat has always been the Japan government bond (JGB) market. The success of Abeconomics is not bullish for this market. Yields should and will rise. However, if the rise is continuous and commensurate, the fact should not derail the strategy. Discontinuous increases and market failure would be a problem. The rise can be offset through debt cancellation but this tool is not yet in use. Purchases of the JGB stock by the Bank of Japan are helping, as is a proposed phased-in increase of the consumption tax. The latter has been raised as a potential obstacle to the success of Abeconomics but, as has been discussed in a previous blog, on this occasion it is probably a net positive.
The investment implications are quite simple and quite obvious. However, it is astonishing how often the obvious is ignored until after the fact. It is time to rebalance equity holdings in favour of the Nikkei over the S&P 500. It is also worth keeping a currency overlay through a long dollar yen position.