Japan: Moving past the tax hike effect

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Fears over an increase in sales tax proved well founded, but a slow recovery since then has also confirmed that the outlook for Japanese equities remains positive, says Tony Roberts, fund manager at Invesco Perpetual.

It is almost six months since the consumption tax rate in Japan was increased from 5% to 8%, and data points since that time have been largely in line with most commentators’ expectations.

Consumption trends were predictably strong ahead of the tax hike, as purchases of everything from durable goods to daily essentials accelerated. The resultant downturn after the increase has been undeniably sharp, with retail sales and household spending data so far seeing only a gradual improvement.

Getting a sense of the underlying strength of the post-tax hike recovery in consumption has been made more difficult by poor weather conditions across Japan this summer, with heavy rains and typhoons dissuading shoppers from returning to stores.

Against this backdrop, GDP growth for the April to June quarter declined by 7.1%, after growing 6%¹ in the previous three months. Despite this, corporate earnings results have been encouraging. Data from Mitsubishi show that companies achieved 23%2 of their full year sales and profit forecasts for the current fiscal year in the April to June quarter, despite the poor economic backdrop. This compares to fiscal first quarter historical averages of around 24%3, and suggests that the positive momentum in corporate earnings remains on track.

There are also reasons to be optimistic about the recovery in domestic consumption. Growth in both regular and total wages (including bonuses) in July was 0.7% and 2.6%4 respectively, the fastest pace of growth for more than five years. While the upward trend for wages is still at an early stage, an environment of low unemployment, at 3.8% in July5, economic recovery and positive inflation should strengthen workers’ bargaining power.

Some uncertainties remain about the post-tax hike recovery, but gaining a degree of clarity on its impact has seen Japan’s equity market recently regain its post financial crisis highs. This has also been driven by renewed weakness in the yen, some speculation about further easing from the Bank of Japan and strength in other global equity markets, notably the US.

The market rallied over the summer, recouping ground lost earlier in the year, and the TOPIX index is little changed year-to-date in local currency terms. In addition, valuations are not stretched and company earnings forecasts are modest, suggesting limited downside and the potential to be revised higher should economic growth resume.

Valuation support, rising earnings, improving shareholder returns and an accommodative central bank all underpin what we believe remains a positive outlook for Japanese equities.


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