BoJ could disappoint in October, but micro developments are key

Michael Stanes (pictured), investment director at Heartwood Investment Management comments on the outlook for the Japanese economy. 

Despite surging ahead in the first half of 2015, the Japanese equity market has reversed much of the year-to-date gains since July. The pullback coincided with a strengthening yen during the period of risk aversion sparked by worries over China’s economic slowdown.

The market has been interpreting recent economic disappointments, including persistently weak inflation, as a sign that the Bank of Japan (BoJ) will provide further policy support, potentially by the end of this month. Japan’s macro picture has been uninspiring. Export levels have deteriorated since March, a large factor being the slowdown in demand from China. But it is not just external demand that has hurt. Private consumption fell 2.7% in the second quarter and that has been in spite of firm labour market conditions.

BaoJ Governor Kuroda has spoken in relatively upbeat terms on the economic and inflation outlook, including his reiteration last week that disinflationary energy trends are likely to be transitory. There are a few signs that the second quarter slowdown is starting to turn around, with the latest household survey report showing consumer spending picking up over the summer, while wage growth is also making modest improvements.

Therefore, we believe there is risk that the market’s hopes of further stimulus at month-end could be disappointed. But in any event, policy support alone is not the ultimate driver of long-term returns. Rather, it is the micro story that continues to be of interest to investors, albeit with the backdrop of policy support. And that is why we have recently taken the opportunity to add to our overweight Japanese equity position, which was established late last year, on this weakness.

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