Japan using currency to capture growth
Japan's new Prime Minister Abe is pursuing a multi-faceted growth strategy including fiscal stimulus, investment and an aggressive monetary policy. A major component of "Abenomics" is to end deflation by making the Bank of Japan (BOJ) responsible for achieving a 2% inflation target by aggressively easing monetary policy via asset purchases, which could pressure the yen.
Expectation of BOJ shift from prior conservatism
* Rebased to Jan. 5, 2007 = 100
Source: FactSet, Federal Reserve, European Central Bank, Bank of Japan. As of Feb. 12, 2013.
The market has started pricing in expectations of more aggressive monetary easing yet to come after new governors are put in place in the spring. The rapid decline in the yen likely reflects the shift in expectations from the past history of an ineffective and tepid BOJ; however a breather might be in order. Oil priced in yen terms has risen 36% in the past six months, which could hurt Japanese consumers and give Abe's opposition the leeway to create a difficult BOJ appointee process.
However, if the BOJ convinces markets it will do "whatever it takes" to weaken the yen, it may become self-fulfilling and benefit Japanese stocks, giving us the mantra "don't fight the BOJ." Relative US dollar strength would reduce returns and investors may want to consider hedging currency exposure.
Increases in sales from market share gains due to a weaker yen could lift earnings, particularly for Japanese companies with high operating leverage. However, the long-term sustainability of relying on a weak currency growth strategy is uncertain, and fundamental corporate change is likely still needed to become less insular and target new growth products and markets.
China's recovery fueled by debt
China's economy is rebounding, led by infrastructure spending, as well as an improvement in exports. However, this been accompanied by a surge in speculative debt from the shadow banking sector, as we detail in our article. China's economy is more reliant on debt than in the past to generate growth, a potentially unsustainable situation.
Chinese-related investments could continue to benefit from the economic turnaround in the near term. However, longer-term investors may want to consider re-orienting international exposure away from China and toward developed markets.
Read more international research at www.schwab.com/oninternational.
So what?
Stock market resiliency continues to impress, although the possibility of a near-term correction exists and we would view such an event as a buying opportunity. The day-to-day noise can distract investors but there are bright spots on the horizon for the US economy that we believe bode well for future growth and longer-term investors.
There are also some development in both Europe and Japan with nascent labor reforms in the former, and a new effort to stimulate spending in the latter, that could develop into longer-term positives. But it's a bit too early to say as history tends to argue against both movements. And China is looking better in the near term, but longer term concerns are growing and a day of reckoning may be coming.
Important Disclosures
The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. The MSCI EAFE Index consists of the following 22 developed market country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.
The MSCI EMU (European Economic and Monetary Union) Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of countries within EMU. The MSCI EMU Index consists of the following 11 developed market country indices: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, the Netherlands, Portugal, and Spain.
The S&P 500 Composite Index® is a market capitalization-weighted index of 500 of the most widely-held U.S. companies in the industrial, transportation, utility, and financial sectors.
The Chicago Board of Exchange (CBOE) Volatility Index (VIX) is an index which provides a general indication on the expected level of implied volatility in the US market over the next 30 days.
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