Japan’s Autumn Is Off to a Fast Start

Is it a new dawn in the Land of the Rising Sun? Last Friday the ruling Liberal Democratic Party (LDP) elected Shigeru Ishiba as party leader and new prime minister, replacing Fumio Kishida. Ishiba’s first order of business: calling a snap election for October 27. While this stirs uncertainty somewhat short-term, Japanese specifics—and economic and sentiment drivers—are worth keeping in mind for Japanese stocks. Let us explore.

Ishiba’s victory capped off an eventful summer. After Kishida removed his name from consideration in August, nine candidates sought the top position in the LDP’s September leadership contest. Cabinet minister Sanae Takaichi, former Environment Minister Shinjiro Koizumi and Ishiba emerged as the frontrunners. Eventually, Ishiba edged out Takaichi by 21 votes in a contest that went down to the wire.

The immediate market reaction suggested investors aren’t fans of the former defense minister and military model enthusiast. The yen strengthened on Friday and Japanese stocks fell Monday, with some economists questioning Ishiba’s supposedly “unfriendly” economic views—e.g., support for Bank of Japan rate hikes and campaign comments about hiking corporate taxes—and whether or not he is a “reformer.”^[i]

But it is a mistake to get caught up in this kind of conjecture. One, there is no evidence low interest rates are all that market friendly. For most of the past eight years, the BoJ employed negative interest rates to encourage bank lending. That didn’t happen—instead, the BoJ’s bizarre monetary policy flattened the yield curve, which contributed to stagnant loan growth. Two, don’t forget politicians’ uncanny ability to moderate once in power—Ishiba has already backed away from suggestions for BoJ rate hikes and said his comments about raising corporate taxes were taken out of context.^[ii] That was fast.

Now, we agree economic reforms (e.g., improving companies’ global competitiveness) could benefit Japan. But these changes would address long-running structural factors—they likely wouldn’t materially affect the business cycle or economic conditions over the next 3 – 30 months. Note, too, “reformers’” effect on market returns is usually overrated. Excitement for change can set high expectations, teeing up potential negative surprise if reality disappoints. Case in point: the late Shinzo Abe’s “Abenomics” program in 2013. Headlines cheered Abe’s big reform talk, and while he made some progress during his long tenure, most of his plans didn’t match the hype—contributing to a stretch of Japanese underperformance. Ishiba’s situation is the opposite today—no bad thing for stocks.

That said, this month’s snap election does raise short-term political uncertainty. What will the next Diet’s composition be? What will Ishiba prioritize if he wins a resounding public mandate? We will monitor developments closely, but the aforementioned Abe’s premiership is a telling example that even huge popularity doesn’t translate to major change in Japan. And Ishiba’s polling doesn’t come close to Abe’s a decade ago. In our view, this seems more like the return of “the revolving door” of interchangeable leaders who fail to inspire much enthusiasm.

Outside politics, Japan made summer headlines for other reasons. At July’s end, the BoJ hiked its short-term interest rate for a second time and announced a quantitative easing (QE) taper, which spooked investors, driving a correction-like downturn in Japanese markets. Many blamed the unwinding of the yen carry trade for the pullback—perhaps true to some degree, though this supposed source of selling pressure was vastly overrated, in our view, as roiled sentiment seemed to be the bigger culprit. Note, Japanese stocks plunged -12.9% in USD (and -9.3% in yen) in the week following the BoJ’s July moves—but they have since bounced back (up 13.5% in USD and 14.7% in JPY).^[iii] That recovery occurred even as money managers’ net short positions in the yen mostly flatlined, suggesting the carry trade’s connection to the market chop is more tenuous than many think.^[iv] 

Despite a few high-profile singular events and summertime volatility, we think markets recognize a sea change hasn’t occurred in Japan. Besides monetary policy’s normalizing, economic fundamentals haven’t changed much. Japanese GDP has vacillated between growth and contraction over the past couple years, with Q2 private domestic demand registering growth for the first time since Q1 2023—reflecting domestic demand’s struggles.^[v] Moreover, markets also recognize Japan isn’t an island^[vi], and global trends tend to override local ones. Hence for Japanese stocks, it still seems mostly steady as she goes.