(Bloomberg) — Political uncertainty will likely weigh on sentiment for investors in Japanese assets after the ruling coalition led by the Liberal Democratic Party failed to win a majority in parliament for the first time since 2009. The yen weakened, and Japanese stocks gained on Monday morning.
Some may be looking to buy on dips, and global investors are still pinning hopes on Japan’s improving corporate governance as a factor to buy equities, even after a gamble by Prime Minister Shigeru Ishiba to call a snap lower house election backfired. Public support for the LDP has nosedived after revelations last year that party members were secretly enriching themselves with funds from supporters.
“The situation is so uncertain,” said Ryuta Otsuka, a strategist at Toyo Securities Co. “The loss for the coalition party has not been fully priced in. Those that have reported earnings and confirmed good performance will not be sold much, and there is a possibility of buying at the dip.”
“In terms of the mid-longer term view, we still think the pieces are in place for Japanese equities to do well. The work on corporate reform, focus on return on equity and increasing capital expenditure by corporates are all still very encouraging, and shouldn’t be impacted too heavily by the election outcome,“ said Alex Cousley, an investment strategist at Russell Investments Group LLC.
“In terms of USD/JPY, the yen looks very attractive on valuation terms but has been that way for a while. If we see a more aggressive selloff in the currency in coming days/weeks and we saw signs that the market had overreacted to the news, that would be an attractive opportunity.”
“The yen has been under selling pressure throughout October and a tight election result probably won’t do the Japanese currency any favors,” said Tim Waterer, Sydney-based chief market analyst at KCM Trade.
“Financial markets don’t deal well with uncertainty and that’s exactly the type of situation that a loss of majority for the LDP would create. From a clarity standpoint investors would prefer to see a more clear-cut result, but that may not be what transpires given the apparent loss of confidence by the public in the LDP.”
Nikkei Not Cheap
“The Nikkei isn’t cheap, traded at 15.28 times the earnings at the end of last week,” said Kohei Onishi, senior investment strategist at Mitsubishi UFJ Morgan Stanley Securities. Even so, it’s likely be range-bound between 35,000 and 37,000, he said, and investors focus will shift to global factors such as US payrolls data and the US elections.
Weak Government
“If we are in a period where a weak government gets nothing done, but the underlying effects of Abenomics, including corporate governance reforms, more workforce participation and strong corporate earnings, remain, then that should be a good thing for the stock market,” said Neil Newman, head of strategy at Astris Advisory Japan.
“The LDP will survive this, and we may get a quick-fire change of PM, but Japan will no doubt just continue to muddle through in its own micro-economic climate.“
Vulnerable Sectors
“Bank of Japan policy should remain accommodative, with even supposed monetary hawk Prime Minister Ishiba recently declaring ‘this is not an environment for raising rates’, and the other parties even more opposed to tightening,” said Richard Kaye, a portfolio manager at Comgest Asset Management.
“The BOJ has largely defied myriad pundits’ expectations of rate rises now for three years, despite more than a doubling of Japanese banks’ share prices apparently anticipating such a move; the bank sector could be most vulnerable now.”
“The yen weakened considerably before the election, anticipating confusion: when a working majority is established, the yen could return to the path of normalization it began in the summer if the yield gap with the dollar continues to narrow. Yen-sensitive sectors like automobiles, steel, trading houses are probably vulnerable.”
Fiscal Risk
In the Japanese government bond market, “interest rates may fall in the short term due to risk-off and political uncertainty, but in the long term, interest rates are likely to rise with a fiscal risk premium in the ultra-long term zone,” said Katsutoshi Inadome, senior strategist at Sumitomo Mitsui Trust Asset Management Co.
“The party may team up with either the Japan Restoration Association or the Democratic Party of Japan, which has pledged to cut consumption tax and income tax, and is likely to pursue expansionary fiscal policies.
“It is likely that the target of achieving a primary balance surplus in FY2025, which the previous Kishida administration had defended, will be abandoned, and the possibility of a downgrade of the government bond rating cannot be ruled out.”
Shorter bond yields are likely to fall as the BOJ will no longer have much leeway to raise interest rates, he said.
Resignation Possibility
“Although there will probably be pressure to sell the yen against the US dollar, there is also a ‘sell Japan’ aspect, so the positive effect of a weaker yen on Japanese stocks is expected to be limited,” said Jumpei Tanaka, a strategist at Pictet Asset Management Japan Ltd. “There is also a possibility that Prime Minister Ishiba will be forced to step down, and this is also expected to weigh on Japanese stocks.”
Downside Risks
“It’s difficult to see the opposition parties coming together to form a cohesive government,” said Gary Dugan, chief executive officer at Global CIO Office. “International investors just want to see the corporate sector continue on a path of restructuring without any noise from politics.”
Weak LDP
“It is important to remember what PM Shigeru Ishiba was originally saying he wanted to achieve: higher taxes,” said Nicholas Smith, a strategist at CLSA Securities. The weaker the LDP is, the harder it is for him to achieve that, which is good for markets, he said. “We got too complacent with a strong, effective prime minister in Shinzo Abe. Most of the time, over the 40 years, politics has been no more than a titillating Punch & Judy show with little impact on markets.”
Coalition Question
“From now on, the LDP and Komeito will have to discuss forming a coalition or cooperating” with smaller parties, said Hirofumi Suzuki, chief foreign-exchange strategist at Sumitomo Mitsui Banking Corp.
“The continued uncertainty in politics will put downward pressure on asset prices. This is a difficult situation for the foreign exchange market. Given the price movements of the previous week, it is likely that the yen will continue to weaken.”
–With assistance from Alice French, Hideyuki Sano, Yasutaka Tamura, Momoka Yokoyama and Ken McCallum.
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