The market tends to pay a different price for small caps that offer growth potential. However, after a strong three years, investors are being asked to pay a higher price now for smaller companies. The core 30 large Japanese companies are paying around 40% more in dividends than their smaller company peers. Smaller companies offer more growth but with more risk.
The challenge with Abenomics has been around the effectiveness of monetary policy, and raising inflation without the structural reform needed to engineer social and economic change in corporate Japan.
Monetary policy alone is no longer having the effect it once did and Shinzo Abe has struggled to put through all the reforms he wants. He did not get the Japanese government to relax strict controls on immigrants working in the country, although the rules on women working have been relaxed, which should offer some benefit to the economy.
In 2016, Abe was re-elected with a convincing majority. Since 2012, the political system has entered a period of stability of the kind that has not been seen for a generation. This suggests the people are willing to give Abe more time to implement his policies.
After four years of Abenomics, the initial ‘shock and awe’ approach of huge quantitative easing and extra spending have run their course. The structural reform, which was always going to be slower to take off, is now beginning to have an effect. Despite the earnings recession over the past 15 months, the dividend and buyback stream has actually risen. This is the first time in the history of corporate Japan that shareholder yield went up during a profits downcycle.
Economic signals are mixed for Japan. The country is a major importer with few natural resources but high demand for energy. It has been a beneficiary of lower oil prices but the full benefit takes time to work through the economy. The oil price rallied in 2016 but it remains substantially lower than it was five years ago.
At the same time, Japan’s nuclear industry is due to come back online, which means the country will not be trapped if oil prices rise too high.
On the other hand, figures from the labour market suggest the Japanese economy is running at full capacity with little room for further expansion. However, a tighter employment market is good for inflation where there is growing evidence that wage and income growth is accelerating.