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'Kishida shock' to stocks shows fear Japan will slide on reforms

Investors question new PM's desire to shake up state capitalism like Koizumi did

Another down day for the Nikkei Stock Average: The benchmark index has fallen for eight consecutive sessions through Oct. 6. (Photo by Tetsuya Kitayama)

TOKYO -- The Japanese stock market has suffered an eight-day losing streak unbroken by the election of a new prime minister, an event that typically produces a rally, in what some have dubbed the "Kishida shock."

The Nikkei Stock Average has retreated 6.8% since Fumio Kishida won the race to lead the ruling Liberal Democratic Party on Sept. 29. About 80% of the benchmark index's gains since August have been wiped out.

Kishida, who became Japan's 100th prime minister Monday, has put international investors in a mood to sell, according to a New York-based hedge fund manager. They fear market-driven corporate governance reforms and structural changes to the country's economy will stall or even backslide to the "bad old days" of Japanese industrial policy prior to the 1990s, this person said.

Fueling this anxiety is Kishida's declared goal of a "virtuous cycle of growth and distribution."

"The meetings I've been having with foreign investors this past week have frankly been difficult," said a strategist at a Japanese brokerage. "They would press me on how Japan can achieve growth, since growth is needed for distribution, and I can't give them a definite answer."

In a note to investors Wednesday, a Japanese equities manager at an international brokerage ripped into Kishida's income-doubling plan, whose name hearkens back to the high-growth-era economic policy of then-Prime Minister Hayato Ikeda in the early 1960s.

"This is perhaps just a meaningless appeal to a 'better time,' aimed cynically at elderly voters -- but it is also a rather ominous suggestion for anyone imagining that Japan still needs to extricate itself from its legacy vestiges of 'state capitalism,' under the direction of powerful bureaucracies," reads the note.

After hitting a year-to-date low in August, the Nikkei average rebounded sharply and reached a 31-year high on Sept. 14, shortly after unpopular former Prime Minister Yoshihide Suga said he would step down. Investors anticipated a changing of the guard in Tokyo with the race to succeed him as LDP leader, but the politics-driven rally has fizzled.

Of course, the sell-off also reflects uncertainties beyond Japan, such as China Evergrande Group's debt crisis and rising long-term interest rates in the U.S. Rising energy prices are also a driver.

That said, the Dow Jones Industrial Average inched up 0.04% between Sept. 28 and Tuesday. The MSCI World Index was off by only 0.5% during the same period. This shows that international factors cannot fully explain the Nikkei average's steep losses.

One possible reason Kishida has inspired such rapid disappointment is his stance on taxing financial income. The new prime minister told his first news conference Monday that raising the tax on capital gains and dividends is "one option" for carrying out his growth and distribution policy.

"The Biden administration is calling for the expansion of the capital gains tax, and there is a global trend toward stronger taxation on the rich to correct disparities," said an analyst at a major Japanese brokerage. "But it's questionable whether now is the right time to advance such a policy in Japan, where disparities are comparatively smaller."

Some market watchers see Japan's financial tax debate as stemming from an outdated view of stocks as a pastime for the rich.

"What Japan needs the most right now is to promote financial inclusiveness, in which people of all walks of life can enjoy the benefits of investments," said Hideto Fujino, president of Rheos Capital Works in Tokyo.

But while retail investors may rail against a financial tax, the proposal seems not to have factored into the sell-off among international investors. Clues to their thinking can be seen by looking at Japanese stock performance under prime ministers dating back to 2000.

Nomura Securities compared the broad TOPIX stock index to the MSCI World Index to calculate a Japan stock premium. External and macroeconomic factors, such as the dollar-yen exchange rate, were stripped away in an effort to determine the true impact of successive Japanese governments on the stock market.

Of the 10 governments since 2000, the one led by Prime Minister Junichiro Koizumi from 2001 to 2006 presided over the biggest bump. Under Koizumi, whose signature structural reform was privatizing the postal savings system that funded inefficient government spending, the premium soared from deep into negative territory to reach the highest levels in the two-decade period. 

Junichiro Koizumi waves goodbye to staff in his official residence as he departs as Japan's prime minister in September 2006.   © Reuters

The pages of the Nikkei newspaper in Japanese since 2000 back up Koizumi's association with structural reforms. A larger proportion of Nikkei articles containing this phrase was published during Koizumi's time in office than during that of any other prime minister.

The premium generated by Shinzo Abe's second stint as prime minister from 2012 to 2020 was small by comparison.

"The equity gains under Abe's government can be almost fully explained by the effects of the weak yen," said Yunosuke Ikeda, chief equity strategist at Nomura Securities. "Just like the growth strategy was a misfire among the three arrows of Abenomics, any other factors that drove share price growth were minor."

"International investors valued [Koizumi's] stance in favor of structural reforms, and that value judgment lifted Japanese equities," Ikeda said.

To some, Kishida's government represents a turning point from the neoliberal agenda that has prevailed in Japan since the Koizumi era.

Increasing efficiency through structural reforms is the only way to achieve growth in a country whose population is shrinking, claims the New York hedge fund manager, who worries that Kishida could put a halt to this push.

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