Benign neglect

Abe can afford to ignore slumping Japan equities

Shinzo Abe can afford to ignore slumping Japanese equities.

That's easier said than done. The 11 per cent slide in the TOPIX index since end-December is an unwelcome reversal of the stock market rally that marked the first year of the prime minister's anti-deflation campaign. It also raises the spectre of a negative wealth effect: Higher asset prices are critical for sustaining private consumption and for giving a boost to corporate investment.

But before Abe responds, he needs to pay attention to the reason behind the stock slump: the rising yen. For much of the past year, equities have moved in lock-step with the currency. The yen's appreciation so far this year has been a manageable 3.6 per cent against the US dollar. When the US Federal Reserve first spooked markets with hints of monetary tightening last summer the yen surged nine per cent and stocks tumbled further. At the time, yields on 10-year Japanese government bonds (JGB) rose to almost one per cent. During the recent sell-off, JGB yields have actually fallen to 0.61 per cent, from 0.74 per cent at the end of 2013.

The risk of asset markets stalling Abenomics with a vote of "no confidence" is much lower now than in May. That's because corporate animal spirits have revived. Toyota's third-quarter earnings quintupled from a year earlier. Hitachi is set to earn a bigger annual profit than it has in 23 years. Meanwhile, tax-free accounts for Japanese individuals and reforms to encourage pension funds to shift cash out of government bonds should channel domestic cash into the stock market. A drop in valuations is more a reflection of tepid global risk appetite than an indictment of Abenomics.

The latter will be in doubt if the Bank of Japan (BOJ) loses control of long-term interest rates, or if a strong yen smothers inflation. Right now, though, long-term inflation expectations are steady at 1 percent, suggesting the real risk-free rate is negative. That's a powerful booster shot for an economy trying to shrug off deflation. If April's sales tax increase causes consumption to fade, the BOJ might yet have to step up its stimulus. But wasting ammunition on stock market gyrations will be counterproductive. For now, benign neglect is the best policy.