Abe Wins Big In Japan, 'EWJ' And 'DXJ' Lower

Japan's Prime Minister Shinzo Abe's ruling party won parliamentary elections Sunday, gaining control of the upper house in a victory that gives Abe the political power he needs to fully implement the structural reforms he wants.

Abe's Liberal Democratic Party's coalition won a majority of the 121 seats contested in the upper house elections, giving Abe control over both houses. As a result of the upper-house election, Japan no longer has each house under a different majority party, as Goldman Sachs economists pointed out in a note published today. That should speed up and simplify the process of getting bills through.

The victory was largely anticipated by the market, which responded with a muted rally-Japan's Nikkei was up roughly 0.5 percent on the heels of the election. Japan-focused ETFs were actually trading marginally lower Monday morning, a reflection that the news had already been largely priced into recent gains, according to analysts.

The iShares MSCI Japan ETF (NYSEArca:EWJ)-the largest Japanese equities fund in the market, with $11 billion in assets-was trading just under $12 a share, about 0.4 percent lower on the day, but still near a two-month high. The currency-hedged WisdomTree Japan Hedged Equity Fund (NYSEArca:DXJ), too, was trading some 0.8 percent lower, facing additional head winds from a slightly stronger yen.

The real challenge now lies ahead, as Abe works to formulate the "third arrow"-or the growth strategy-of his so-called three-arrow policy. The first two were "monetary stimulus" through the Bank of Japan; and "fiscal stimulus" from the government side. Little is actually known about how Abe plans to spur growth in an economy long beaten down by deflation and a strong currency.

According to governing parties in Japan, this growth strategy should be unveiled sometime in the fall, with promotion of capital expenditures through tax relief coming in as the centerpiece, Goldman Sachs said. The investment bank added that it doesn't expect more "significant proposals" such as cutting effective corporate tax rates or major labor market reform to be announced any time soon.

The Third Arrow

Many had argued that the July 21 parliamentary election was the last hurdle Abe needed to clear before fully implementing his policy plans.

"I'd look at the second half of the year, as the time frame for when we are going to see what they have up their sleeves to deal with some of the big structural changes Japan needs," WisdomTree's director of Research Jeremy Schwartz said in a recent interview. Schwartz is currently in Japan on account of the election.

"Japan has to deal with an aging demographic; high uncompetitive tax rates; and tax incentives to increase foreign investment in the country. A lot of this is going to play out in second half of the year," Schwartz said.

The Japanese yen was trading just under 100 to $1 Monday morning, showing some muscle after having been as low as 103.18 to the dollar as recently as late May.

"The central risk is that Japan is one of the most indebted countries in the world," Schwartz said. "They have a high deficit-they do a lot of spending-and they have to fund that deficit spending through the issuance of new debt, and yet they also have one of the lowest interest rates in the world."

In other words, Japan is a high-debt, low-interest-rate country.

"If they're going to have growth, they need to get out of this deflationary trap they've been in," Schwartz said.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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