Views From the Floor - After Abe

What does the death of a titan mean for the Japanese economy?; and the cost squeeze for European midcaps.

After Abe

The murder of Shinzo Abe shocked us all. Although Abe stepped down as Japan’s prime minister in 2020, he had continued to lead the largest of the ruling Liberal Democratic Party’s seven factions. With no clear successor in Abe’s faction there may be an opportunity for Fumio Kishida, current prime minister and leader of only the fourth largest faction, to consolidate power. Haruhiko Kuroda’s term as governor of the Bank of Japan (BoJ) also ends in April 2023, adding to the uncertainty. Together, Abe and Kuroda were the key architects of economic policy over the last decade and it seems to us that Japan may be entering a new era for economic policy and a changing of the guard. Kishida, having had to consult Abe about major decisions in the past, could have more free rein to work on his brand of “New Capitalism” which focuses primarily on wage growth through strong company profits, rather than ultra-loose monetary policy.

The likelihood of significant policy change under new monetary and political leadership hinges on inflation trends, in our view. Though the BoJ is focused on data excluding food and energy, Japan’s headline inflation has now been ahead of the official 2% target for two consecutive months (Figure 1), as global dynamics interact with domestic initiatives that seek to address the cost of living (such as fuel subsidies and pressure on mobile-phone companies to reduce bills).

For their part, most Japanese companies have yet to send a signal on wage rises; these salary decisions tend to happen once a year. Local businesses have also historically felt the need to largely absorb higher input prices themselves, rather than pass rising costs onto customers. Business-to-business industries are currently having greater success, but even business-to-consumer industries are having to pass on more costs than they would have in the past.

As stockpickers rather than macroeconomists, these are the developments we will be watching in the months ahead, while remaining aware of a possible policy shift around the time of Governor Kuroda’s retirement.

Figure 1. Consumer Price Index for Japan, Annual Change Before Seasonal Adjustment

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Source: Bloomberg, Statistics Bureau of Japan; as of 24 June 2022.

European Midcaps: Rising Costs, Falling Prospects

As midsummer passes, spare a thought for the CEOs of European midcaps.

Energy costs are rising across the continent (Figure 2), with natural gas prices in mid-July approaching the extreme levels seen in March, despite limited consumer heating demand. Not every company is well positioned to absorb the shock, with smaller firms more likely to have no energy hedging policy in place. This may be exacerbated further if gas flows from Nord Stream 1 do not resume, with the possibility of energy rationing (prioritised to consumers) becoming very real.

Likewise, rising inflation is prompting unions to demand wage rises, with IG Metal (the major German metalworkers’ union) demanding an 8% rise, and airport ground staff negotiating for 9.5%.

If the global slowdown does tip into recession, European midcaps may therefore find themselves in a difficult position, with sharply rising costs, yet prevented from passing these to consumers by falling demand. Unless we see a significant change to the geopolitical backdrop before winter, and slackening inflation, we feel that there may be tough times ahead for European midcaps – and in contrast, opportunities for long/short managers within the region.

Figure 2. European Natural Gas Prices at Extreme Levels

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Source: Bloomberg; as of 31 May 2022.

 

With contributions from: Adrian Edwards (Man GLG – Portfolio Manager) and Brentley Campbell (Man GLG – Portfolio Manager)

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