Last week, the Japanese Prime Minister Shinzo Abe, announced that he was to step down from the role owing to ill health. Last year he become Japan’s longest serving Prime Minister, having held the office since 2012. He will remain in place until a successor is found, ensuring the continuity of his economic policy that’s known as Abenomics. But what is his economic legacy and has it been a success? That’s the Big Conversation.
When Shinzo Abe came to power in 2012, he inherited a political position that was notoriously hard to hold onto, with the post changing hands 16 times since 1990, including a one year stint of his own from 2006. That he stayed in the post for an eight-year period is truly remarkable, with only Prime Minster Koizumi’s five year period from 2001 coming close during the previous three decades.
Abe immediately set about implementing a three-arrow policy of monetary and fiscal stimulus, combined with structural reforms that were seen as being complimentary to each other. Individually, these policies were unlikely to have succeeded, but in unison, they would have a much better chance of hitting home. Pushes for structural change had historically struggled to take hold in a country notorious for its conservatism, but the repeated cycles of failed policy and failed prime ministers had started to alter popular opinion.
Was Abenomics successful and will the impact of the COVID-crisis derail any of the reforms that have taken place? Abe came to power in the aftermath of the 2008 global financial crisis and the devastating earthquake and tsunami of March 2011, an event that also triggered the Fukushima nuclear emergency.
Japan’s economy had been reeling from other economic structural headwinds long before these events took place. The equity market and property prices had moved into bubble territory in the late 1980’s, before imploding. Neither have recovered these former levels and the TOPIX Index is still over 40% below the all-time highs, thirty years later.
Two of the overriding issues for Japan has been her aging demographics and the use of excessive government debt to try and replenish the growth that was lost with the bursting of the bubble and its declining working age population. Japan’s government debt-to-GDP has soared to over 250%, but unlike other countries which have seen the ratios blowing out during the current crisis, Japan’s debt ratio has been marching higher for the last 25 years.
The use of increased government debt levels had been an attempt to combat a level of GDP growth that had all too frequently slipped back into negative territory – the 2020 bust is the 9th occasion since 1990 in which quarter on quarter GDP has dipped below zero, though this one is by far the most dramatic.However, the declining population means there are fewer workers able to contribute to GDP. Maintaining GDP growth without population growth is an uphill struggle, unless there are significant improvements to productivity. Japan has seen an increase in the number of women in the workplace, but this demographic dividend is coming to an end.
But Japan’s households have continued to build up their savings. Japanese households are some of the largest global creditors, influencing many different asset prices and geographies as they hunt for yield in other regions.
You can see on this chart the narrow range that Japanese 10-year bond yields have been in for the last couple of decades, compared to most other major economies. Other countries are now catching down to Japan, especially where demographics are now becoming a head wind as they are in many parts of Europe. As a result of these low yields and flat yield curves, Japanese banks have also been fighting a losing battle. The ratio of the TOPIX Banks Index versus the broad TOPIX Index is close to an all time low, having been in a fairly distinct downward trend since the early 1990’s.
Until Abenomics kicked in, the Japanese equity market had largely followed the fortunes of the US 10 year yield. When yields were rising, reflecting reflation and global growth, the Japanese Equity Market performed well. When yields were falling Japanese equities tended to be on the back foot. US 10-year yields have been in a downward trend for most of the last 30 years. Abenomics appeared to make a clean break from this pattern, signaling a policy in which Japan’s domestic policies, rather than global growth trends, could take control. On the face of it, it looks like Abenomics helped lift the equity market out of it never ending slump.
For a while, Japanese equities also outperformed, in local terms, the US equity market, although the global manufacturing slumps of 2015 and 2018 again took a greater toll on Japan’s industrial base. The S&P has once again left Japan behind, but this is more a reflection on the US equity market rather than on Japan. But Japan’s equity market is cheap on many metrics – and Warren Buffet thinks so, recently investing $6 billion in trading houses that will also benefit from inflation.
The move in the equity market was initially spurred by a policy that would weaken the Yen, pushing USDYEN higher, although explicit FX intervention had to be avoided. At the time, USDYEN had been carving out a three year reverse head and shoulders formation, which provided a great technical backdrop to support a significant move on the back of a massive policy change. But what were some of the main tools at policy makers disposal?
Japan’s Debt-to-GDP ratio continued to expand, though at a slower pace than during many of the previous 10 years. Fiscal tools such as government expenditure had been of primary importance prior Abenomics. Now, it would be the monetary side that would go into overdrive, with the bank of Japan’s balance sheet expanding at an impressive pace, largely because interest rates had already hit close to rock bottom in the immediate aftermath of the bursting of the equity and property bubbles in the early 1990’s. Interest rates would be cut again, but it was the size and speed of the balance sheet expansion, used to fund purchases of bonds and ETFs, that really catches the eye.
The recent expansion of the Fed’s balance sheet, in terms of absolute size, is a talking point behind the recent weakness in the USD, but the BoJ balance sheet as a percentage of GDP is far in excess of that of the US. This ratio beats both the ECB and the Fed by a considerable margin.
The BoJ is has also implemented yield curve control, but in this instance, it is to stop yields falling too low and impairing the commercial bank’s earnings even more than they have already, rather than to stop yields rising too far and impacting the ability of the government to pay interest on its debt – although they will be extremely sensitive to that possibility. The Bank of Japan has already bought a significant proportion of the government’s bonds in circulation. One of the stated aims of the three arrows policy was to raise the levels of inflation. In the initial aftermath of Abenomics, there was some limited success in raising the rate of inflation and overall levels have been slightly higher in the last couple of years than they were in the 2000 to 2010 period, but no one could claim that the policy has had a lasting effect on inflation. Demographics remain a major headwind and apart from the unlikely event that Japan changes its immigration policy, inflation looks like it will remain subdued unless the US Administration can create true global reflation.
One area in which it could be argued that Abenomics has had a notable success is the decline in employment, though this trend was already in place and coming off a high base after the great financial crash of 2008. Even after the recent pandemic induced spike, the unemployment rate is only around 3%. These job losses, like in many other parts of the developed world, are largely in the hospitality and leisure industries and will be reliant on the speed with which people feel comfortable returning to former levels of entertainment.
Perhaps a clearer sign of Abe’s structural reforms is the reversal of years and years or rising inactivity, i.e. the number of people ‘not in the workforce’. Abe encouraged women into the workplace, though the benefits of this policy may have already played out.
Average hours worked Japan has also seen cultural shifts taking place, with long hours and jobs for life being replaced with a more dynamic and vibrant economy, with technology becoming increasingly important in maintaining productivity levels even whilst the working population ages and declines. Japan’s consumer sensitivity has mainly come from changes in the level of the sales tax. Every now and again, Japan’s administration tries to recoup some of the fiscal outlays of the previous decades. Each time the sales tax rises, Japan’s household expenditures dip and this puts pressure on GDP. The Abe administration attempted this on a couple of occasions and the outcome was the same.
A pressing issue was always the governments expenditure and especially the net interest payments. A country which need to raise debt in order to pay for interest payments on existing debt is usually in a perilous position. Japan’s position under Abe has improved and are currently close to their lowest level in 40 years. But that is as much to do with the global decline in bond yields rather than any specific policy within Abenomics.
And in many ways the global growth picture has been at the heart of the success or failure of Abenomics. Abe certainly did change the rigid structure of Japan’s formal employment economy, instilling a level of workplace dynamism that would have been at odds with the glacial changes that underpinned much of corporate Japan in the post-War years. However, all that Abenomics can do is temper the demographic trends and not reverse them. The key one is in demographics where people aged older than 64 (the green shaded area) has continued to rapidly increase, whilst the population aged under 15 has generally been falling. The birth-death ratio is unlikely to ticks through the magical 2.1 level any time soon.
Abe’s successor will inherit these structural impediments and will no doubt continue the monetary and fiscal policies that he or she inherits. It is difficult to see how Japan can wean itself off a monetary policy that appears intent on buying up all the listed securities available with Japan. The US and Europe have been watching Japan with interest. Global yields have converged lower towards those of Japan and these then developed market blocks are pursuing ever larger levels of monetary and fiscal intervention. Abe’s legacy was one of structural reform, but it was also one of supercharged fiscal and monetary expansion. IF ABENOMICS HAD FAILED, THE GLOBAL MARCH TO MODERN MONETARY THEORY MIGHT HAVE BEEN CHECKED, BUT THE MILD SUCCESSES OF ABENOMICS HAS EMBOLDENED GLOBAL POLICY MAKERS TO FOLLOW DOWN THE PATH THAT WAS BLAZED BY SHINZO ABE AND HIS ECONOMICS TEAM.
The US equity market is displaying some incredibly unusual features at the moment. The difficulty for analysts is working out what are the key drivers of the market at any one time. We have outlined on many previous occasions that this is a market driven by flows and not fundamentals. Last year we asked whether valuations still matter and earlier this year we talked about how high equity prices do not equate to a bubble, unless they are also associated with heightened emotions.
Today we have a large number of technical factors that are screaming for a reversal – and now that doesn’t mean necessarily a major reversal, but it does increase the asymmetric risk of a downside airpocket. Last week we looked at how the data usage across the Refinitiv Eikon platform had fallen far more than we would usually expect at this time of year. It not just that traders are sitting on the sidelines, they are sitting on the beach after an extended period of market fatigue. Last week we also looked at the very unusual divergence between the S&P500 and the VIX. Its rare, but not unheard of, for the S&P500 to make new all time highs whilst the VIX, which is the implied volatility of the index – or what people are actually willing to pay for options – is increasing. Not only is the VIX going up today, but its doing so at a time when the S&P itself is grinding out new highs with a very low level of realized volatility (realised volatility is the actual or historical volatility of the index). Thirty day realized volatility is at 10, whilst spot VIX is at 26. If you wanted to buy protection, you would effectively be over paying for it. Very few people are – if people are pricing for US election risk, it appears they are more worried about a break out than a break down.
In fact, what has been happening is that people are buying call options. Call options minus put options as a percentage of New York Stock Exchange volume have skyroketed to the highest level ever. The maturity (or time left before they expire) on the largest 100 names in the S&P500 have been averaging 2 weeks – these are short term positions looking for a quick buck. We saw a spike in the VIX into the dot-com S&P500 peak in 2000. Just prior to the volmageddon blow up of February 2018, we had seen call volatility on the increase. Do measures such as these now matter far more than investor sentiment, because the investors who participate in the surveys are the active investors who are being increasingly sidelined by the rise of rules abased investing, where market capitalization, volatility and momentum are more important than earnings?
S&P profits have been flatlining for five years even as the index soars to new all time highs. “This time is different” is a much-maligned saying because excesses tend to unwind, but what if the full cycle timeframe consists of a full investment cycle. For the last five years at least, this time HAS BEEN DIFFERENT and it may continue to do so for another few years for all we know. Price earnings and earnings per share have had little to do with large cap investing over this period. US value stocks have been lagging growth for years, but this has taken on a supercharged quality over the last 6 months in a trend that had started even before the COVID pandemic took hold, picking up with the Feds repo efforts from October last year. What is growth versus value? Tech is growth and banks are value and you can see the same performance in the ratio between the Nasdaq100 and the US Banks index, the BKX. The biggest stocks have been getting much bigger, at a much faster pace than the smaller cap names. Apple alone, at 2 trillion is about the same size as the whole of the Russell 2000 small cap index, although the market cap and the earnings of the tech and communications sectors are both equal at around 40% of the index, its just that these sectors have been increasingly concentrated in a few hands. This large cap effect is even clearer when we view the US discretionary sectors, where the automobile sector looks like a standout performer. However, this is nearly all tesla, the rest of the sector is comprised the usual dullards of the auto industry. This trend of concentration and acceleration shows no sign of abating. Most people will also now be familiar with the influx of retail investors, not just to the US market, but globally, including Brazil and many parts of Asia, who have also jumped on many of these trends. Have they piled in in sufficient quantities to create the emotional froth that normally accompanies a major market bubble? Are institutional investors still suffering the ill effects of the pandemic period? It would appear that, in some quarters, they have also regained animal spirits.
The National Association of Active Investment Managers exposure index has returned to the all time highs. This has been coincident with prior market peaks, but there have also been similar readings during periods where the S+&P500 continued to march higher. JP Morgan have recently suggested that asset managers are around 41% equity in balanced funds versus a high closer to 49%, suggesting there is still more room to add equity and push prices higher. The Reuters Asset Allocation poll also shows equity holdings are well below their peaks within balanced funds, at about 43% versus a peak of closer to 50%. Whilst some of the active manager surveys still suggest there is room for upside, are lots of shorter term technical indicators, are driven by emotion, that suggests the market is massively overbought. The S&P500 is banging up against a medium term trend line which would once have been a catalyst for many tactically minded asset managers to start reducing some of their equity exposure. But this group of investors are no longer in the driving seat. Share buybacks in tech stocks, shadow banks leveraging commercial bank’s balance sheets for high frequency trading and retail investors using short dated bonds for leveraged plays on single stocks are some of the main protagonists in a market which currently has much lower volumes than the late summer period experiences.
But the framework is still in place for a short sharp pullback. Volatility is pushing higher (though it’s the realized and not the implied levels that matter for most rules-based funds). Hedging costs are increasing, whilst the costs of long call options positions is reducing the likely chance of a positive return. Perhaps more worryingly is the likelihood that, as markets continue to rise, the need for more policy intervention reduces. This market likes liquidity and the best way of getting that is if the equity market undergoes a short sharp correction that kicks starts the Senate’s fiscal negotiations and gives the Fed another green light to find yet more assets to buy under their QE infinity program.
When we were filming on location in the London’s financial district a couple of months ago, it was clear that the majority of workers had remained at home even after lockdown measures were eased. Many estimates suggested that the number of financial workers who had returned could be as few as 15% of the total workforce. It was also clear that back to work trends in other UK regions were much stronger, especially where the urban centers were less crowded in the first place. Now that we are coming to the end of the vacation period in the northern hemisphere, there’s been a lot of discussion about PEAK WORK FROM HOME and the expectation that workers will now start to return to the office.
Andrea Stone of Refinitiv, looks at the work from home data usage and how return to work trends are differing by region.
Is the rise of working from home a permanent phenomenon for financial markets? With covid we've all had to shift our balance of working in the office to working from home. We wanted to take a look at that picture and see if there was any variance by country or by job type. Would this show us nation's collective attitudes around the response to covid and the return to work? We took a look at our customer usage patterns with a very simple hypothesis. If you were logging on to the desktop, you were most likely in the office, and if you were logging on to Eikon Web, you were most likely at home. We then compared that to geo location data from Google and found some interesting trends. Here in red you can see Google's data on commuting levels in India, and in blue moving in the other direction, Eikon users log on via the Web. Globally, the picture is clear. Web logons as a proportion of total logons rose 600 basis points in the first three months, and they are still far higher than they were in 2019. Country by country, there's far more nuance. You can see that in the UK the initial jump in web usage and that real stickiness in that number even as corona cases have fallen. By contrast, users in France, Italy, Spain and Germany are slowly drifting back to the office. The question for France and Spain in particular, is whether that trend continues as cases spike again or have attitudes relaxed? We'll be watching these numbers in the upcoming weeks. Hong Kong is interesting with two increases in home loggins; one in February and a second in July as cases have resurged in recent weeks. The other interesting trend is among users in Brazil, Russia and India, who appear to have gone into lockdown well ahead of the actual virus threat. As for the U.S., web usage has climbed about 500 basis points from a pretty high base before the crisis, and has broadly remained there irrespective of infection levels. So what do these countries snapshots tell us? The decision to work from home is probably more to do with local conditions, local infection rates, local lockdown's, local attitudes than it is to do with the job role you perform, whether it's trading, M&A, asset management, wealth management, risk, middle office or back office. Our data shows very little variation in how job roles have responded to the covid crisis. It looks like what we're seeing is a slow and cautious attitude in the return to the office, but it is happening gradually. We'll get a firmer view on how the markets will get back to business, most likely after the US completes its Labor Day holiday. We'll let you know what the data shows us.
Its clear that the work from home mentality kicked into gear even before some of the lockdowns were imposed. Regions where transport networks are crowded, such as the City of London, also appear to be showing a greater reluctance to return to the workplace. The UK government is now having to tackle this reluctance head-on. We should expect workers to drift back to the office from now, but its clear that the impact of COVID 19 has allowed a re-evaluation of the workplace. How emphatic that will be will probably become clear over the next few months, during the September to mid December period which is usually one of the busiest times for financial markets.
It's clear that the work from home mentality kicked into gear even before some of the lockdowns were imposed, regions where transport networks are crowded, such as the city of London. Also appear to be showing a greater reluctance to return to the workplace. And the government in the UK is now having to tackle this reluctance head on. We should also expect workers to drift back to the office from now. But it's clear that the impact of Cauvin, 19, has allowed a reevaluation of that workplace. How emphatic that return will be will probably become clear over the next few months, due in September to mid-December period, which is usually one of the busiest times for financial markets.
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