8/6/2019 2011-06-15 AXA IM Weekly Comment Japan - V-Shaped Rebound Confirmed

1/3

Research & Investment Strategy

Weekly Comments 547 15th June 2011

J apan: V-shaped rebound c onfirm ed

www.axa-im.com

AXA Investment Managers Paris, a company incorporated under the laws of France,

having its registered office located at Cur Dfense Tour B La Dfense 4 100, Esplanade du Gnral De Gaulle 92400 Courbevoie.registered with the Nanterre Trade and Companies Register under number 353 534 506a Portfolio Management Company, holder of AMF approval no. GP 92-08, issued on 7 April 1992

Key points

Sharp recovery in the pipeline, due to inventoryreplenishing and private consumption.

Growing threat of power shortages during thesummer.

Taxes will probably be raised in 2012 and 2013.

The Japanese market seems to have discounted alot of negative news but is not outright cheap.

Start moving back into the marketat least if youare an investor who does not follow a benchmark.

Three months after the terrible earthquake of March 11,which ravaged North-eastern Japan, the country is justnow starting to bandage its wounds. A V-shapedrecovery in the coming months is not doubtful in theleast, but the consequences of the catastrophe, both onthe political and economic fronts, are giving rise to fearsof a delay over the summer.

A deep and destabilising though temporaryshock

Japans national accounts for Q1 cast a stark light on theeconomic impact of the earthquake. Quarterly GDP fellby 0.9% even as a rapid recovery was shaping up inJanuary and February. It comes as no surprise thatinventories are way down and household consumptionhas ground to a halt.

The Japanese recovery is gathering pace

30

35

40

45

50

55

60

2004 2005 2006 2007 2008 2009 2010 2011

-12

-10

-8

-6

-4

-2

0

2

4

6

%yoy

Manufacturing PMI index

GDP [RHS]

Source: ESRI, Datastream, Bloomberg, AXA IM

All economic indicators confirm that the trough wasreached in April and that the recovery began in May. Theimprovement is quite palpable in the manufacturingsector, with a PMI reading that moved once again above50 points in May. The forecasts from the Minister ofIndustry give reason to hope that the rebound will extendinto June at least, with high monthly growth rates (8% inMay and 7.7% in June). Still on the supply side, servicesrebounded in April, correcting for 40% of the declineobserved between February and March.

In the short term, the economic rebound is obviouslybeing driven by the recovery in production for the sectorsthat suffered the most from the earthquake. Thereplenishing of inventories will also play a critical rolebecause the latter, already substantially diminishedduring the financial crisis, had not yet been fully restoredbefore the earthquake.

On the demand side, the decline in business activitylevels led to substantial job losses (-600,000) betweenFebruary and April. A plunge of this magnitude inemployment over two months had not been seen inJapan since the first oil crisis of 1974. Initially, the badnews on jobs focused all of the fears of Japanesehouseholds, but the real threat to the morale of the

Japanese consumer is actually more in terms of incomegrowth over the medium to long term. Indeed, theearthquake weighed adversely on corporate earningsand, in this context, it is difficult to anticipate higherbonuses for wage earners in the months ahead. Thisbeing said, the contraction in payroll, related to a one-offshock, should only be transitory. The economic recoverywill be accompanied by a rise in employment and this willin turn provide more solid support for consumption.

We can also expect to see an uptick in privateconsumption in the run-up to the possible, if not probable,VAT hike in 2013 and the impact on income in 2012. We

will revisit what was until recently a taboo subject; butthere is a very good chance of seeing a repeat of thescenario observed in late 1996early 1997. At the time,the Hashimoto governments decision to raise the VATfrom 3% to 5% led to a sharp rise in private consumption just prior to the actual hike, followed by a deepdepression in the two quarters that followed.

Therefore, it seems to us that consumer spending willremain hesitant in Q2 but will thereafter become a driverof growth, particularly at the end of this year and into the

8/6/2019 2011-06-15 AXA IM Weekly Comment Japan - V-Shaped Rebound Confirmed

2/3

Japan: V-shaped rebound is confirmed 15th June 2011

Research & Investment Strategy AXA Investment Managers _____________________________________________The written material contained herein was completed on June 14 2011 2

beginning of next. Vehicle registrations in April and Maywere in line with this scenario, revealing a certain wait-

and-see attitude despite the recovery underway.

Risk of power shortages this summer risingsteadily

The summer, which corresponds to peak demand forelectricity, is increasingly a cause for alarm. Theconsequences of the earthquake are being felt not only inthe regions devastated by the disaster, but throughoutthe country. Many businesses have in fact moved theirproduction westward, and this has led to durably higherthan normal demand for power. At the same time, thenuclear power plants that have been shut down formaintenance have not yet reopened. In mid-June, 37reactors out of 54 (which is 14% of total electrical powerproduction capacity) were shut down, with four additionalreactors possibly joining them in early July.

So the risk of shortages is real, and not just in andaround Tokyo. In early April, we estimated the elasticityof GDP to electricity production to be around 0.2, and weconcluded then that this would shave anywhere from 0.2to 0.4 percentage points off GDP growth in Q3, based oninadequate production just for TEPCO. Taking intoaccount the nuclear power plant closures across thecountry, the impact could be as high as 0.6 percentagepoints in the worst case.

The risk of a debt spiral is pushing thegovernment to think about higher taxes

Beyond the risk of power shortages, the magnitude andthe workings of the government reconstruction programfor the devastated regions will also have an impact on therecovery. The first budget add-on was adopted in May,equal to 0.9% of GDP. This plan will be totally financedthrough the reallocation or the reduction of expendituresalready programmed, to avoid the risk of a newdeterioration in the countrys sovereign debt. Theprincipal rating agencies have clearly warned thegovernment against debt-financing the reconstructioneffort. So there should not be any additional demand, andstimulation of the economy will be based solely on themultiplier effect of expenditures.

A second stimulus plan, the magnitude of which could bebetween 2% and 3% of GDP, is currently being workedout and could be adopted sometime in August. It nowseems to be a foregone conclusion that this second planwill be financed via the issue of reconstruction bonds,which would be distinct from traditional bonds forconstruction and for financing the deficit. One of thespecific features of these reconstruction bonds lies intheir repayment structure, which would come through

dedicated tax revenue. A report will be submitted to thegovernment on this subject at the end of June. A VAT

rate hike is an increasingly likely scenario under thecircumstances.

This second stimulus plan will be decisive in determiningthe speedy return of Japans GDP to growth, though theinstability at the head of the executive branch could slowdown the process. The main question at this pointconcerns early elections if PM Naoto Kan were to resignbefore a vote is taken on the plan, at a time when hisparty is more divided than ever. Although hypothetical,this scenario is weighing adversely on investors morale.

Appealingly priced equities? Not so fast!

Surprisingly, international investors kept buying theJapanese stock market at least until very recently, whilst

domestic investors moved to the sidelines as earningsexpectations of the Kabuto-cho tumbled. We think thatthis movement is not over yet. Earnings will most likelyremain depressed until i) the full impact of the pastrecession has been digested, ii) the currency starts toweaken significantly, and iii) the Asian recovery showssigns of traction.

Yet a big chunk of negative earnings seems to be pricedin. Different classic valuation measures suggest that themarket offers value for the long-term investor. Currently,Japan trades at 5.7x price/cash flow compared to 8.9x forthe entire MSCI universe.

However, on a more forward-looking metric such as thePEG ratio, the Land of the Rising Sun trades almost atpar with global markets (1 standard deviation below itsaverage). This clearly shows the degree to whichinvestors doubt current earnings and earningsprojections. We also know, however, that Japaneseearnings are more a function of volume than anythingelse. If production recovers, earnings should find a solidunderpinning and thus offer a decent floor to currentvaluation. We therefore suggest increasing the weightingof the Japanese market in the months to come, at leastfor those investors who are not tied to a benchmark.

ConclusionsA V-shaped recovery is likely, but the bottleneckcaused by electricity production woes and politicaluncertainties could disrupt the rebound, at leasttemporarily, over the summer.

We think that GDP will shrink in 2011 by 0.3%,followed by a rebound of 3% in 2012. Longer term,the inevitable rise in tax pressures will weigh, at leastinitially, on the outlook for growth, especially as thecountrys potential growth converges more and moretoward zero.

Herv LIEVORE & Franz WENZEL

8/6/2019 2011-06-15 AXA IM Weekly Comment Japan - V-Shaped Rebound Confirmed

3/3

Japan: V-shaped rebound is confirmed 15th June 2011

Research & Investment Strategy AXA Investment Managers _____________________________________________The written material contained herein was completed on June 14 2011 3

This document is used for informational purposes only and does not constitute, on AXA Investment Managers Paris part,an offer to buy or sell, solicitation or investment advice. It has been established on the basis of data, projections,forecasts, anticipations and hypothesis which are subjective. Its analysis and conclusions are the expression of anopinion, based on available data at a specific date.

Due to the subjective and indicative aspect of these analyses, we draw your attention to the fact that the effectiveevolution of the economic variables and values of the financial markets could be significantly different from the indications(projections, forecast, anticipations and hypothesis) which are communicated in this document.

Furthermore, due to simplification, the information given in this document can only be viewed as subjective. Thisdocument may be modified without notice and AXA Investment Managers Paris may, but shall not be obligated, update orotherwise revise this document.

All information in this document is established on data given made public by official providers of economic and marketstatistics. AXA Investment Managers Paris disclaims any and all liability relating to a decision based on or for reliance onthis document.

Furthermore, due to the subjective nature of these analysis and opinions, these data, projections, forecasts, anticipations,hypothesis and/or opinions are not necessary used or followed by AXA IM Paris management teams or its affiliates whomay act based on their own opinions and as independent departments within the Company.

By accepting this information, the recipients of this document agrees that it will use the information only to evaluate itspotential interest in the strategies described herein and for no other purpose and will not divulge any such information toany other party. Any reproduction of this information, in whole or in part, is unless otherwise authorised by AXA IMprohibited.

Neither MSCI nor any other party involved in or related to compiling, computing or creating the MSCI data makes anyexpress or implied warranties or representations with respect to such data (or the results to be obtained by the usethereof), and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness,merchantability or fitness for a particular purpose with respect to any of such data. Without limiting any of the foregoing, inno event shall MSCI, any of its affiliates or any third party involved in or related to compiling, computing or creating thedata have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits)even if notified of the possibility of such damages. No further distribution or dissemination of the MSCI data is permittedwithout MSCIs express written consent.