The Week In Hindsight, 16 June 2014

The NIKKEI joined global equity indices in their retracement to lower levels last week as worse than expected US economic data, and a sudden escalation of unrest in Iraq, saw investors hit the panic button after weeks of calm trading which drove volatility gauges to an all time low.

In terms of economic data closer to home, the corporate goods price index came in above expectations for the month of May, with an annualised reading of 4.4% vs expectations for a price increase of just 4.1%.

In addition to the upward movement in prices, data detailing the impact of the consumption tax increase upon core machinery orders (capital expenditure indicator) revealed a less severe effect than many had anticipated. During the month of April, orders contracted by 9.1% vs expectations for a reduction of 11.5%. Further from here, as referenced last week, final Q1 GDP also came in above expectations with a reading of 1.6% vs expectations for a print of just 1.4%.

All in all, the picture painted by Japanese economic data since the April consumption tax increase has been brighter than many had anticipated. Despite this, and on the downside, both the BOJ Governor as well as the Prime Minister have recently made statements which indicate ongoing concerns over the economy.  

Kuroda described JPY exports as below expectations last week while stating that aggressive monetary easing will continue for at least a year from now, given that the economy remained “only half way toward” the point where it could maintain stable inflation at the 2% level.

In addition to this, Shinzo Abe appears to be suffering from some level of indecision over whether or not to go ahead with phase 2 of the consumption tax increase from 8% to 10% next year. The Prime Minister stated in a recent announcement that the government would be able to say for sure whether it will go ahead by the close of 2014, indicating that underlying concerns remain as to whether or not the economy could withstand another increase.

On a slightly more positive note, for the longer term, Abe also announced a plan to cut Japan’s corporate tax rate from the current 36% (large companies), to below 30% over the months and years ahead. The move is intended to promote foreign direct investment in Japan.

While a tax cut alone is unlikely to prove effective in prompting a notable increase in FDI, it will place Japanese corporates in a better financial position to raise wages, which is a fundamental requirement of any scenario which sees a successful and sustainable recovery taking place in Japan.

Going forward, we expect the core policy maker focus to remain on wage growth and inflation. Given the uncertain outlook for both, we expect monetary policy to remain loose but within the current setting. This is supportive of a stable outlook for Japanese equities, while changes to the investment strategy of Japan’s largest pension fund and the potential for an awakening of a sleeping behemoth (JPY household cash assets) adds further to the investment case for JPY stocks.

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