Will Japan Inc Start Using Cash?
Source: FactSet, Bank of Japan. As of Sept. 9, 2014.
We are encouraged by policy moves to improve corporate governance and the return on equity of Japanese companies. Corporate cash could be unlocked by either returning money to shareholders or increasing investment to improve productivity. Japanese stocks could perform well in the near term despite Japanâ€™s longer-term structural issues; particularly if changes to corporate taxes, the asset allocation of the Government Pension Investment Fund (GPIF), and extension of the Bank of Japanâ€™s (BoJ) QE, are enacted.
China: a tenuous balancing act
In contrast with many other countries, China needs less investment and more consumption. Positively, Chinese policymakers have undertaken a long-term reform plan to transition away from a government-directed economy toward one that is market-based. However, these reforms are likely to slow growth, so the trick is to pursue reforms at a pace that keeps growth from slipping too much. As a result, the economy could experience bumps up and down.Â
Investors are still getting accustomed to both slower, as well as more variable, growth in China. Concerns about debt defaults and payoffs earlier this year resulted in fears about an economic hard landing, but the relative stability in the economy has encouraged investors to begin returning to Chinese stocks.
We are encouraged by a stabilization in Chinese exports and emerging market growth overall. This is despite still sluggish European and Japanese economies, as emerging market countries increasingly transact with each other. The United States remains a major export destination for many countries, and the strengthening of its economy adds to Chinaâ€™s growth.
However, interest rates, and therefore credit, remain somewhat restrictive, as the effective rate for corporate borrowers is often higher than published rates due to extra fees and costs imposed by banks; and favorable mortgage rates are reserved for borrowers with large bank accounts. The government is still testing new targeted easing measures during the transition to a market-based economy, which could result in policy mistakes in the interim.
We believe the Chinese government has plenty of levers to stimulate growth in the event it slips too far. Despite the concerns about infrastructure overbuilding, Chinaâ€™s economy still has room to improve in the basics of water and energy. As examples, the second leg of the $62 billion South-North Water Transfer Project is set to open in October, highlighting the water issues in China; and reportedly the government recently has been considering a $16 billion investment in electric car charging infrastructure.
Although Chinese stocks may need to take a breather, and the property market remains a longer-term risk, we believe there is more upside. Chinese stocks are likely to benefit from further stimulus, attractive valuations, and continued reform moves, as well as the upcoming cross-exchange Shanghai - Hong Kong Stock Connect (SHKSC), or â€œthrough train.â€
Additionally, we are warming to the overall emerging market stock universe due to a stabilization in growth and because emerging market stocks are one of the few asset classes where valuations are attractive in what has become an increasingly expensive world. Read more international commentary atÂ www.schwab.com/oninternational.
A correction is always possible and risks are all around but we believe a relatively strong U.S. economy can help to support further gains in stocks and that inevitable pullbacks should be used as buying opportunities. Fed timing and election uncertainty could raise volatility, so be prepared for some bumps along the way.Â The ECB finally acted but we are skeptical it can stimulate demand and more structural changes are needed; while Japan could continue to perform well in the near term. China faces a tough balancing act and stocks may be due for a near-term pullback, but we remain positive on Chinese and emerging market equities.