Cash Is Another Reason to Own Japan
Market insights from the international investment professionals at Euclid Advisors:
Japan’s latest core consumer price index reading, released last Friday, rose 3.3% in July, marking the fourteenth consecutive year-on-year increase. Excluding the impact of April’s sales tax hike, July CPI is estimated to have risen 1.3%. While inflation remains shy of the Bank of Japan’s 2% target, we view the latest CPI as evidence that Prime Minister Abe’s “three arrow” policy continues to gain traction. Monetary easing was the first arrow of Abenomics to be deployed, ahead of fiscal and economic reform, because the BoJ could basically make it happen by printing yen. There was no need to pass legislation and the government did not have to worry about economic growth as it would with any fiscal reform.
With Japan’s CPI slowly climbing versus being nearly flat a year ago, real bond yields have turned negative. During the preceding period of deflation, it made sense for corporations to accumulate cash and enjoy positive real returns. Now that financial repression is in place (i.e., negative real interest rates), cash may become an unwelcome drain. Corporations will need to go from cash hoarders to cash disposers, or suffer an annual reduction in the value of their balance sheets. One-half of Japanese companies have positive net cash (cash less total debt) compared with less than one-quarter in the U.S. Merrill Lynch estimates that Japanese companies have over $600 billion in cash sitting on their books.
Share buybacks are a likely use of excess corporate cash and should be rewarded by the market, given the heightened investor and government focus on enhancing ROE. And, as more Japanese households (re-)enter the stock market, we expect rising demand could encounter diminishing supply (due to buybacks), which could exert an additional upward bias on prices.
The way we see it, changing views on the use of cash, together with fiscal and economic reforms, add up to increased potential for attractive returns for investors in Japanese equities.