Has Japan’s Revolving Door Returned?

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Friday, Japanese Prime Minister Yoshihide Suga surprised many, announcing he won’t seek re-election as Liberal Democratic Party (LDP) chief almost a year after taking office. Hence, the country will get a new prime minister shortly after September 29’s party vote—with the victor likely leading the LDP into the general election, due by November 28. Japanese stocks jumped on the news, with many observers suggesting a “more charismatic” leader who champions additional fiscal stimulus could help reduce Japanese stocks’ huge lag versus the world. But we think that oversells it. This shift is likely to prove little more than a personality change, and it could signal the return of Japan’s revolving door that saw eight prime ministers lead the country between 2006 and 2012. The ouster of an unpopular leader could perk sentiment some short term, but we doubt this does anything material for Japan’s longer-term fundamentals.

In explaining his decision, Suga cited the country’s struggles with the Delta variant, claiming he couldn’t simultaneously campaign for the leadership post and do his job running a country facing a crisis. That is a good-sounding rationale, but most observers think the actual explanation is simpler: Suga’s approval rating is … bad. When he took office following long-tenured Shinzo Abe’s resignation on health grounds last September, Suga’s cabinet was actually quite popular. According to broadcaster NHK, its approval was 62% immediately after appointment. Other polls put it even higher, hovering near 70%. Suga is the son of a strawberry farmer and hails from the rural north, not Tokyo. He put himself through college by working at a factory before entering politics, giving him a particular “man of the people” appeal.

However, that initial shine faded fast. Suga was an ardent champion of the country’s efforts to restart domestic tourism under a program called, “Go To Travel.” This program, unveiled in July 2020, offered substantial discounts and subsidies for Japanese residents to travel domestically. The thought: With international borders closed, Japan’s huge international tourism sector would suffer. Suga and other “Go To Travel” champions thought it would spur domestic tourism and bolster domestic demand in the process. At the time, it was slated to expire in March 2021. As summer turned to fall and eventually fall to winter, COVID cases ticked higher, which many tied to the travel program, leading some critics to darkly dub it, “Go To Hospital” or even, “Go To Heaven.” Suga rejected these assertions and even backed an extension of the program on December 8. But when cases spiked the following week and his government’s approval rating tanked, he reversed course and suspended the program.^[i]

In February, as Japanese COVID cases receded some, news broke that Suga’s son, who works for a private telecommunications firm, was involved in improperly wining and dining 11 LDP officials, a violation of government ethics laws. Then came the Olympics, a divisive issue in the country. Suga pressed for them to continue despite broad opposition amid the country’s slow vaccine rollout. So when the Delta variant came and cases across the country surged, his cabinet’s popularity suffered even more. In August, NHK reported just 29% of Japanese approved of its performance.

In most countries, a 29% government approval rating two months from a general election would imply the opposition taking power. But that doesn’t apply in Japan, where the LDP still dominates all other parties. Polls show somewhere on the order of 30% – 35% of voters support the LDP. They could have lost seats in the Diet, but with no other party polling in double digits, they would likely remain the senior party in a coalition government.

The bigger question was whether Suga would retain power or fall. For weeks, the presumption was Suga would try to hold on, likely by calling for an early general election ahead of the leadership vote or reshuffling the cabinet. In theory, a good showing in a national vote could have bolstered his support within the party. But now it is clear that won’t happen—his popularity simply fell too far.

Furthermore, in most countries, a sitting leader surprisingly announcing he won’t seek the post anew amid a national emergency would stir uncertainty, hit sentiment and likely hurt stocks. But in Japan it has people seeing an opportunity. Many analysts think a new, more charismatic, possibly younger leader could renew efforts to reform Japan’s long languishing economy and deploy vast fiscal stimulus, echoing Abe’s 2012 – 2013 “Three Arrows” campaign. They are already dissecting the possible cast of characters for the leadership contest. Many claim this underpinned Japanese stocks’ jump Friday after lagging badly for most of 2021. (The MSCI Japan is currently up just 4.2% this year, more than 14.4 percentage points behind the world.)^[ii]

In a country with sentiment as deeply depressed as this, seeing a very short-term jump based on a flicker of optimism doesn’t shock us. But the reality is, nothing fundamental has really changed. Japan has had no shortage of fiscal stimulus in recent years. The country has enacted multiple extra budgets totaling over a trillion US dollars in an effort to “stimulate” growth just since COVID began. That doesn’t even account for vast measures under Abe and earlier. Japan is a poster child for stimulus not working as planned.

As for economic reform, Abe had some success at the margin, but he failed to advance many others targeting less protectionism and more economic dynamism. This was the longest-serving prime minister in Japan’s history—the man who stopped the revolving door. If he couldn’t push through sweeping reforms, why would a newcomer fare better now?

Ultimately, Japan’s impending change at the top isn’t a game changer for stocks. We still expect domestically oriented Japanese firms to lag, even if it isn’t as extreme as we have seen over the past few months. While we don’t suggest ignoring the country, as it can offer valuable diversification opportunities, we think its export-oriented firms are better positioned.