Despite the negative headlines, Japan’s massive QE relaunch should buoy equities in the short to medium term, says Ian Heslop manager, Old Mutual Global Equity Fund and Old Mutual World Equity Fund.
Markets were spooked this Halloween, not by the usual ‘witching hour’ that sees futures contracts rolled over, but by an announcement from the Bank of Japan. Having spent just $1trn on quantitative easing since March last year, the BoJ said it will now spend more, faster, and with greater emphasis on lower grade instruments.
The new QE programme will run through US$700 billion a year. The proportion spent on lower quality credit instruments, particularly exchange traded funds and real estate investment trusts, will increase three-fold.
Trick or treat?
We don’t know what would have happened had there been no QE, but it is a policy of which the results are mixed. The US and the UK were the earliest proponents of the policy, launching programmes respectively in November 2008 and January 2009. Since then, the US has poured US$4.5 trillion into buying up government and mortgage-backed bonds. The UK spent £375 billion buying government bonds.
In both cases, economic growth turned positive within about 12 months of the start of QE and the US and the UK are currently the best performing economies amongst the G7 nations. Annualised growth in the UK was 3% in the third quarter and 3.5% in the US. In both countries, housing and employment conditions have improved markedly. Unemployment in the US is now 5.8% and in the UK 6.2%, levels well below their post-crisis peak or those of their competitors in most of western Europe.
The impact on asset prices has been significantly more powerful. Since the beginning of QE in the UK, the return on gilts has been 45%. The FTSE All-Share index has gone up 94% and the FTSE 250, the index of mid-cap stocks, has gone up 200%. In the US, again since the beginning of QE, the S&P500 has returned 138% and the Russell 1000 144%. The Nasdaq has risen 179%.
The experience of Japan has been less conclusive, despite the headlines. Having spent US$1 trillion since launching QE in March 2013, the Nikkei 225 is up 42%, though it has risen 84% since mid-November 2012, when investors started to see that Shinzo Abe would win a clear majority in the looming election on a programme of aggressive fiscal and monetary reform.
Abe’s programme consisted of three ‘arrows’.
- The BoJ would spend $1 trillion over two years with the aim of supporting a consumer inflation rate of 2%
- The government would increase spending by 2% of GDP
- A programme of structural reform would open up agriculture, healthcare and energy to more competition and push for freer trade
The Japanese experience was complicated by a number of factors. The first effect of the promise of reform was a sharp devaluation in the yen – by 33% against the US dollar between mid-October 2012 and mid-November 2014. This was in itself a significant benefit to Japanese exporters and the Nikkei 225, which reflects the fortunes of Japan’s large global companies, rose in an exact line with the exchange rate. Many of these companies, while accounting in yen, manufacture offshore.
Unemployment fell quickly in Japan once QE was underway, from 4.5% in the latter half of 2012 to 3.5% in September 2014. The closely watched jobs-to-applicants ratio reached 1.10, suggesting 110 jobs for every 100 applicants, the highest it has been since the early 1990s. Price deflation has dogged Japan for many years, discouraging spending and investment. QE seems to have had an immediate impact, with consumer prices starting to rise from March 2013 and the national inflation rate reaching an annual rate of 3.7% in May this year. Economic growth turned also turned around, from a contraction of 3.5% in Q3 2012 to growth of 4.1% in Q1 2013.
The problem is that the positive impacts appear to have been short-lived. Inflation started to track down from September, as did the jobs-to-applicants ratio. Growth fell off in the third and fourth quarters of 2013. It made a strong comeback in Q1 2014, at an annual rate of 6.7%, but this seems to have been a rush to beat a rise in sales tax from 5% to 8% in April. In Q2 GDP collapsed by 7.3%, with a marked fall in household spending, and then fell into recession with a fall of 1.6% in Q3, when recovery was forecast.
While the top-line numbers have generally been good, discounting the volatility in the growth statistics, the promised programme of structural reform has made little progress. Ultimately, the people who would need to make the greatest sacrifices, farmers, local retailers and small businesses, are the very people who vote for Abe’s Liberal Democratic Party.
The new QE programme, announced on 31 October, amounts to a rapid and emphatic response to the weak growth figures. It is a clear demonstration that the Japanese authorities remain committed to reviving the economy. Equity investors need to be cautious for the longer term but optimistic for the short to medium term opportunities.