Japan Election to Reinforce Abe's Economic Agenda

Japanese voters go to the polls on July 21 to elect half of the upper chamber of parliament.  With the Prime Minister Abe and his cabinet enjoying strong support and the economy recovering, even if deflation has not been completely eradicated, the coalition government is widely expected to secure a majority.  This will end the split in the Diet and ensure Abe has the legislative support for his economic program.

Previously, it had appeared the Abe would not be content with a simple majority.  It was thought a 2/3 majority was desired to secure sufficient support for his political agenda, which includes constitutional changes to strengthen its military capabilities.   This seems considerably less likely now.  An important implication of this is that the focus on Abenomics will not be diluted by shifting the agenda toward politics.  It is not so much that Abe is giving up on it, but rather a tactical adjustment to the strategic goal.

For the two-party government coalition to gain a simply majority it needs to win 63 seats. For the LDP itself to win a majority it needs win 72 seats. The LDP is projected to win 65-70 seats and its coalition partner, the New Komeito (NK)is expected to win 10-11 seats. This will give the government a solid majority and allow it to appoint the chairs of the chamber's standing committees.

The numbers simply are not there for the government to command a two-thirds majority. That would require the government to win 103 seats. This is not simply a matter of voter preference, but the LDP itself appears to have chosen not to seek a 2/3 majority. It is not fielding enough candidates. The LDP 78 candidates running and the NK has 21 candidates. Even if they all win, which is unlikely, the government will be shy of a 2/3 majority.

Moreover, the NK is considerably less supportive of constitutional reform than the LDP. Theoretically, the LDP could form an alliance with the Your Party and the Restoration Party, which are more sympathetic to the constitutional changes Abe has in mind, but together a 2/3 majority would still be elusive.

Provided there is no significant surprise, we expect the results to be supportive for Japanese stocks and bonds, while potentially weighing on the yen. Although we had previously discussed why small cap Japanese shares had outperformed the large cap shares, in the recent advance, they have lagged. The JASDAQ had easily outperformed the Nikkei since Abe's election was discounted, starting mid-Nov 2012 and it peaked a week before the Nikkei. The JASDAQ bottomed first, but the recovery has been more limited. The Nikkei has retraced more than 61.8%, suggesting from a technical perspective that a run toward the earlier highs near 15950 is likely. The JASDAQ approached a similar retracement earlier in July and has since traded sideway below it.

Abenomics calls for industrial consolidation. The Financial Times quotes one senior government official noting that Japan has "too many players in a lot of sectors, leading to low profitability. We need to find ways to encourage consolidation and restructuring." Ironically, Japanese officials do not seem to link the excess capacity to deflationary forces and instead see deflation as a monetary phenomenon. Nevertheless, smaller cap Japanese companies are likely take over candidates, which may support valuations.

There is a potential down trend line for the dollar that connects the late May high near JPY103.75 and this month's high near JPY101.55, which comes in just below JPY101 on Monday. We expect this trend line to be penetrated and for the dollar to test the JPY102.00-JPY102.50 area.