This article, by Francois Buclez, chief executive and chief investment officer at Cube Capital, an investment house, examines the economic policies and implications of “Abenomics” – named after Japanese premier Shinzo Abe.

Editor’s note: This article, by Francois Buclez, chief executive and chief investment officer at Cube Capital, an investment house, examines the economic policies and implications of “Abenomics” – named after Japanese premier Shinzo Abe. The Japanese stock market, while still up strongly on the year, has seen sharp falls in recent days; the yen has fallen sharply, and there are still question marks about the full extent of Abe’s reform intentions. This article adds to the debate that will be closely watched by wealth managers.

Abenomics has, in the past few months, fundamentally shifted the market perception of the risks and rewards of policy action in Japan. For the time being, the enormous monetary expansion instigated by the Bank of Japan has been highly successful in pushing investors into risk assets, as witnessed by the rapid inflation of the Nikkei and depreciation of the Yen.

The package of quantitative easing announced by the Bank of Japan in March was truly radical, making clear that policy makers are deadly serious in their attempt to finally cure Japan of its deflationary curse.

In effect, the BoJ has announced that it will ensure in two years a monetary expansion roughly equivalent to what the US Federal Reserve has achieved in five years, in an economy a third of the size. Overall Japan’s monetary base will double.

What is more, by primarily purchasing long-term government bonds, with an average duration of seven years, the BoJ has committed to a significantly longer QE period than previously undertaken. Whilst Fed minutes indicate easing in the US may stop by year-end, Japanese central bankers are breaking new ground.

The impact of policy on equity prices and the exchange rate is clear, though whether this creates the desired increase in inflation expectations is yet to be seen.

Where then does this leave investors? Though Japan has offered previous false dawns, the pure scope of monetary expectation offers the best chance in years of serious change in Japan’s economic settlement.

Investors have so far been highly optimistic about Abenomics' scope for success. The Japanese benchmark (of equities) has risen 44 per cent in 2013, on the back of a belief that monetary action will weaken the yen, boost corporate competitiveness and increase domestic consumption.

So far these assumptions look to be bearing fruit. The Japanese economy grew at the fastest rate in the Group of Seven countries last quarter, with the stock market at a five-year high.

In sum, for the time being at least, investors have shifted their perceptions of Japan’s potential.

Worries

The question of whether or not this optimism is warranted will be played out over the coming months and years. There are, however, worrying signs amid the positives. For instance, business investment in new plants and equipment fell for the fifth consecutive quarter in the first three months to March, signalling that corporate Japan has yet to fully embrace the recovery.

Another unanswered question is whether Japan’s conservative consumer base can be shaken out of the deflationary, savings culture, mindset. Even if this is the case, consumer spending and inflated stock markets will not be enough without corporate growth.

One key area where the market may be over-reaching itself has been in Japanese real estate stocks, where developers were typically up 30-40 per cent in April. Whilst massive quantitative easing should be expected to boost the real estate sector, realistically this prices in an extremely optimistic real estate boom that would only be played out over a number of years.

These valuations do not make sense. Japan’s poor demographic outlook in the years to come is a clear indication that a real estate boom is unlikely.

In terms of supply, Japan’s urban centres have extremely high land prices. In the short term, cheap capital and a rosier outlook for real estate may prompt a large supply response. However this may ultimately store up more trouble, causing pressure on rents and occupancy.

Investors should therefore be very cautious about following the herd into Japanese risk assets, or at least particular classes of risk asset. The market is currently pricing itself into positions that are, at best, unassured and, at worst, nonsensical. Whilst recovery may succeed, it may not be without casualties.