Abenomics: Still Waiting

It's the Hanami festival ("flower viewing") in Japan these days. To celebrate the coming of spring and the blooming of the cherry blossoms (sakura), outdoor picnics and parties are held all over the country. The blooming period lasts only for a few weeks, and it's a time for renewed hope and fresh plans for better days ahead.

When Shinzo Abe took his turn through the revolving door that is the Japanese Prime Minister's chair, there was plenty of optimism in the air too. Japan's economy was moribund, and Abe had 3 arrows to jolt it back to life.

Arrows 1 and 2 (monetary stimulus and fiscal stimulus) were easy. The Bank of Japan announced an open-ended QQE to expand monetary base by 62 trillion yen in 2013, and 70 trillion yen in 2014. He also loaded up on 10 trillion yen in additional government spending.

The goal was to bring inflation back up (since deflation had taken hold since the late-1990s). So, what happened?

If you were long Japan in the first half of 2013, you were sitting pretty--MSCI Japan outperformed the MSCI World Index by a healthy margin. GDP expanded, the yen weakened, and CPI was up.

But this new painted and polished hood was hiding an as-yet-unrepaired main engine. The 3rd arrow (structural reform) was supposed to take care of that.

Except Mr. Abe hasn't even aimed that arrow yet. Heck, it's doubtful he has even drawn it from his quiver...if it's even there to begin with.

You see, Abe has talked very tough about economic reform, which is sorely needed. The labor code, the corporate tax system, the demographic trend, trade--all need serious overhaul. Except talk is cheap, and the action is not happening.

Some argued that 2013 House elections in Japan meant he had to play it safe after arrows 1 and 2. Okay. His party did well. We're still waiting on the 3rd arrow.

He has announced general, vague targets. But targets are not proposals, proposals are not bills, and bills are not (yet) laws.

And MSCI Japan is noticing that the easy work of the first 2 arrows is done, but the tough reforms aren't forthcoming. It has now underperformed in aggregate since Abe's election. And that recent sales tax hike isn't helping (Q1 1997, anyone? Aka, the last time Japan's economy turned in a positive growth story?).

There are a lot of vested interests standing in the way--the powerful agricultural lobby, Japan Post, the general bureaucracy. But there are some strong factors in Japan's favor as well. It's very wealthy, with a top-notch infrastructure and on the cutting edge of technology.And the finishing touches will be on a free trade agreement with Australia this summer, hopefully paving the way for more to come (with Canada, the EU, and the TPP all underway).

Does anyone realistically expect Japanese stocks to outperform again this year? Might there be some individual gems in the Nikkei?

Tempting as it is to just write off the whole country as a disaster area to be avoided (which I know most of us do), I find it hard to believe that the world's third largest economy of 127 million people is just devoid of opportunity.

Let's pour some sake outside and talk about it.