Japan's snap election looms, but should investors be worried?

 
Katherine Denham
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There seems to be no end to the tidal wave of elections at the moment. And now it’s Japan’s turn to head to the polls after Prime Minister Shinzo Abe decided to call an election a year early.

Abe hopes to bump up his parliamentary majority, and the general consensus is that he will remain in the driving seat.

The Prime Minister’s tough stance on North Korea has pushed him higher in the popularity stakes, and he hopes to take advantage of the strength of the country's recent GDP figures, while preventing opposition party – Party of Hope – from having time to rally more support.

Read more: Japan's Prime Minister Shinzo Abe calls snap election

Since the snap election announcement on 25 September, Japanese stocks have shifted up a gear. The benchmark Topix index is trading at a two-year high, indicating that investors are relatively relaxed about the looming election.

And if the ruling party stays in power, the broad consensus is that shares in Japanese stocks will continue to nudge upwards.

But nothing is ever certain in election outcomes these days, and there is inevitably a risk that Abe’s plan to gain a bigger majority could backfire.

The ruling coalition – between the Liberal Democratic Party and Komei – could be forced to scale back its two-third majority, echoing Theresa May’s recent election disaster.

If Abe loses his majority, not only will he resign, but this is likely to be the final nail in the coffin for so-called Abenomics – causing markets to wobble as investors scramble to understand what this means for Japan.

But perhaps the bigger risk from a political perspective is whether Haruhiko Kuroda will be reappointed as the Bank of Japan governor, because an end to Kuroda’s reign could be the end of the zero-rate environment.

“As long as Abe gets a decent majority, and is not significantly weakened, then that reappointment will go ahead,” says Fidelity fund manager Nicholas Price.

“If Abe does poorly and is not able to get Kuroda reappointed, then that is obviously a factor that could impact the yen and the market’s sentiment.”

Japan has had a turbulent past, but things have been looking up for the world’s third largest economy after it posted the sixth consecutive quarter of GDP growth for the first time in more than 12 years. Economists expect Japan to continue to grow in coming months.

Andrew Rose, who heads up the Japanese equities team at asset management giant Schroders, says 2017 is shaping up to be an exciting year in Japan, pointing to the recovery in corporate profit growth, which has largely been overlooked by investors who have been preoccupied by concerns around North Korea and the US.

The Schroder’s fund manager says we could be looking at another period of political stability in Japan, with a continuation of the economic policies that have supported the equity market.

Compared to other developed markets, Japanese stocks are attractively valued and largely under-owned by investors. The trick is finding the good stocks to invest in, particularly in the small and mid cap arena where analyst coverage is pretty thin on the ground.

Price says it’s a case of “turning over the stones” to find the good companies.

With that in mind, investors might be best leaving the small company stockpicking to a fund manager.

While a handsome election win might invigorate the “three arrows” of Abenomics, Rose reckons it could incite Abe to enact the real love of his life – which is to reform the country’s pacifist constitution.

But Abe has other strings to his bow, promising to spend more on education and childcare, with revenue from a planned consumption tax hike in 2019. He also pledges to allocate cash to cope with the challenges of Japan’s ageing population.

Of course the ongoing labour shortage in Japan creates investment opportunities, particularly with companies in the automation space.

Investors should also continue to benefit from improving corporate governance, which is one of the main successes of Abenomics.

Inflation entered positive territory last year, bolstered by the weaker currency. Investors would therefore be wise to tap stocks that can benefit from an improving inflation picture.

The political question mark will hang over Japan until the election on 22 October, but overall the backdrop looks fairly benign. So whatever the outcome of the election, there’s plenty for investors to feel confident about.

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