Japanese Stocks Are Up, But Don't Fall for the Trap

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Japanese stocks hit a new 2012 high today (Wednesday) and the yen weakened to a 20-month low against the U.S. dollar as Shinzo Abe was installed as Japan's 96th prime minister.

Abe, who served as prime minister in 2006-2007 but stepped down due to health issues, has vowed to pursue aggressive monetary easing to end deflation and get the Japanese economy growing again.

But the long-term implications of Abe's policies aren't as rosy as the short-term stocks boost.

"The hope is that Abe's promises of fresh stimulus, unlimited spending and placing a priority on domestic infrastructure will be the elixir that restores Japan's global muscle," said Money Morning Chief Investment Strategist Keith Fitz-Gerald. "As a veteran global trader who actually lives in Japan part time each year, and who has for the last 20+ years, let me make a counterpoint with particular force -don't fall for it."

Japan's Policy Changes

One of the promises Abe made during this month's election campaign was to pass a 10 trillion yen ($117 billion) supplementary budget for the current fiscal year, which ends March 31, 2013. Abe reiterated his call for the supplementary budget to be passed quickly.

The new government will formulate an "Emergency Economic Plan" by Jan. 11, 2013, which will be incorporated into the 10 trillion yen supplementary budget and will then be presented to the Diet on Jan. 15. Changes to the tax code will be prepared by mid-January, which are likely to include a major cut in the corporate tax rate.

Abe's biggest changes will likely be to Japan's central bank policies.

At last week's meeting of the Monetary Policy Committee --the BoJ's equivalent to the Fed Open Market Committee (FOMC) --the Committee decided to "review the Bank's price stability goal."

In other words, the central bank, which already has an inflation target of 1%, will decide on whether it should raise the target to 2% as Abe has demanded.

In addition, the BoJ last week decided to allow private sector banks to fund the net increase in new lending at the overnight call loan rate of 0.1% for a period of up to four years. The central bank hopes to encourage banks to lend more money by making loans more profitable.

Effect on Japanese Stocks and Yen

Financial markets have been anticipating an economic recovery in Japan. The yen has weakened against most major currencies and is now standing at a 20-month low against the U.S. dollar.

Yen weakness has been interpreted as good news for Japanese exporters. Japanese stocks are at a 2012 high as investors buy manufacturers of export goods such as cars and electronics. Construction shares are also higher in anticipation of extra government spending on public works projects and earthquake recovery.

The yield curve has steepened in the Japanese government bond (JGB) market with long-term rates rising ahead of an expected increase in inflation as the result of Abe's policies. Even so, 10-year JGBs yield only 0.79%.

Japanese Stocks: Long-Term Concerns

While the new policies may result in a short-term pop in economic activity, as Money Morning's Fitz-Gerald pointed out, there are other forces at work that are weakening the Japanese economy over the long term.

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