Time to Buy Japan? Line and Nintendo Prompt Nikkei Outperformance

The Nikkei 225 surges 9.2% this week, buoyed by strong performances by Nintendo and Line, as investors await a government stimulus package.
By Mariko Iwasaki ,

The Nikkei 225, which has dropped nearly 20% in the past year, is regaining momentum as hopes mount for Japan's government and the central bank to work their magic to pull Asia's second-largest economy out of a prolonged period of stagnation. But to what length will the leaders go? The answer should become clearer later this month but in the meantime the Nikkei 225 rose 9.2% this week, outperforming its other international counterparts. 

To be sure, the market has partly been buoyed by tech names such as game maker Nintendo (NTDOY) , which released a new game Pokemon Go, and messaging app operator Line (LN) - Get Report , which made its debut on the Tokyo Stock Exchange on Friday.

However, the larger sentiment that has swept the market is heightening expectations for meaningful measures by the nation's leaders, especially since the ruling parties enjoyed a victory in the July 10 upper house election. Taking this as a public nod to the government's policies, Prime Minister Shinzo Abe instructed Nobuteru Ishihara, the minister in charge of economic and fiscal policy, to compile a stimulus plan to pave way for Japan to exit its deflationary economy. The package is expected to be complied by the end of July.

The stimulus package is likely to exceed ¥10 trillion ($94 billion), the largest in four years, and involve issuance of construction bonds to be directed for public projects such as constructions of ports and hotels to support tourism, and facilities to enable increased exports of agricultural produce. While there are concerns that that the stimulus will further hurt Japan's fiscal stamina, the need to bring fundamental changes to stimulate the economy is undeniably there.

Nintendo's shares soared 70% over the past week following the game maker's release of Pokemon Go. Today, Line made its biggest debut on the Tokyo Stock Exchange to date this year, closing the day up 32% from its offer price and valued at over ¥900 billion. It also debuted in New York yesterday.

In the week following the Sunday election, the Nikkei 225 continued to climb and rallied 9.2%. While some cynics take the view that the rally is simply an immediate and perhaps short-lived congratulatory reaction to the election results, the degree and the length of it may in fact represent the level of frustration the market is posing towards an economy that has repeatedly delayed its promise of fully exiting a deflationary state and achieving growth.

Indeed, the Bank of Japan has delayed its goal of achieving a 2% inflation rate twice. The goal, first promised for within two years of January 2013, has now been extended to 2017. In June, Abe delayed the timing for raising Japan's sales tax rate for a second time on the back of poor consumer spending. The tax hike from a rate of 8% to 10%, originally set for October 2015 but delayed once to April 2017, is now scheduled for October 2019.

On Wednesday, the Cabinet Office lowered its real GDP outlook for 2016 to 0.9% from its January estimate of 1.7%. The government cited clouded outlook for the global economy as well as weak consumer spending and private sector demand.

Yet, it is still unclear how urgent the Japanese leaders are in making change. Despite the GDP downgrade, the Cabinet Office said that the economy has "been making significant strides toward achieving economic revitalization and overcoming deflation thanks to the measures implemented under Abenomics."

Meanwhile, the BOJ has maintained that Japan is on a moderate recovery trend. While the central bank is widely expected to ease its monetary stance in the next policy meeting scheduled on July 28 and 29, there may be a discrepancy in perception between the bank and the market. Since introducing a negative interest rate of minus 0.1% in late January, the central bank has not changed its, with Governor Haruhiko Kuroda repeating that he expects some time is necessary for the measure to take effect.

Its counterpart the Bank of England surprised the markets yesterday by maintaining its rate at 0.5% despite expectations for a cut to 0.25%.

Still, there have been some hints that the Japanese officials are changing their tune. When Fed former governor Ben Bernanke visited Tokyo this week, Abe told him that he wants to accelerate the nation's exit from deflation. Bernanke reportedly proposed the introduction of so-called helicopter money, or perpetual bonds, to stimulate the economy, advising that there were many more ways for the central bank to loosen the monetary system.

Such outside pressure may be one factor that is pushing Japan to its edge. Last month, the International Monetary Fund said a stimulus package would not be enough for meaningful growth, and that in addition to monetary and fiscal policies, income policies and labor market reforms should come to the forefront.

The U.K.'s decision to leave the European Union on June 23 may also push officials. The Nikkei 225 was no exception among the global markets in being hit by the outcome of the vote, suffering the biggest decline in 16 years of almost 8% the following day.

Since then, however, the index has outperformed other markets, gaining 10.3% since June 24, a day after the referendum votes were counted. That compares with advances of 6.3% for the Dow Jones Industrial Average, 6.2% for the S&P 500, and 8.4% for the FTSE 100.

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