Market Analysis

Is the LDP DOA?

Japan's ruling Liberal Democratic Party suffered a stunning defeat in the upper house election on Sunday, giving up control in the chamber to the opposition Democratic Party of Japan. What does it mean for global stocks?

The ruling Liberal Democratic Party (LDP) suffered a stunning defeat in the upper house election on Sunday, giving up control in the chamber to the opposition camp, led by the Democratic Party of Japan (DPJ).

Of the 121 contested seats, the DPJ won 60 seats against the LDP's 37, many of them traditional LDP strongholds. Despite talk of stepping down, Prime Minister Shinzo Abe has vowed to remain at his post, and that decision was backed by the LDP. For more color on the weekend's election, see:

Abe's Election Defeat May Slow Changes in Japan
By Sebastian Moffett, The Wall Street Journal (*site requires registration)

A loss by the LDP was widely forecast, but the party fared far worse than most expected. Political scandals, highly publicized gaffes, and fallout from lost pension records proved too much for the LDP to overcome.

It's encouraging that Abe vowed to stay in power and didn't resign as a knee-jerk reaction to the election results. However, there's bound to be some political uncertainty in the near future as members of the LDP and others debate Abe's political future.

For background on Japan's system of government, see our past commentary, "Abe on the Outs?" (6/25/07).

In an election exit poll by the Asahi newspaper, 56% of respondents said Abe should resign, and opposition parties will likely continue to push for Abe to step down. In addition, DPJ leader Ichiro Ozawa has vowed to push for a general election to win control of the lower house. An early general election would be risky for the LDP, which won its biggest majority in more than three decades in 2005. Abe has said he will not hold an early general election and will reshuffle his cabinet instead.

The LDP still controls the lower house by a wide enough margin to overrule the upper house, so while the upper house loss will make it more difficult to pass legislation, it won't bring the LDP's legislative agenda to a complete halt. For now though, Japanese markets could see some increased volatility until Abe's fate is clearer.

The passing of the election could very well end up being a relief to investors who've anticipated an LDP loss for some time. Japanese stocks were flattish today in reaction. In the long term, however, meaningful pro-market reforms promoted by the LDP will prove difficult to pass—likely a negative for Japanese markets.

On a positive note, the DPJ has vowed to keep Japan's consumption tax at 5%. However, the DPJ is much less inclined to lower corporate tax rates, is in favor of minimum wage and overtime pay hikes, and will champion spending projects such as establishing an income supplement system for farmers, financial assistance to couples with children, and projects viewed as pork barrel spending.

Should Abe step down, likely candidates to replace him include Foreign Minister Taro Aso and former Finance Minister Sadakazu Tanigaki. Both men ran against Abe in party elections in September, Aso was runner-up to Abe. Either way, a member of the LDP will remain as prime minister.

Aso's views are most closely aligned with Abe's as he favors deregulation and smaller government. Tanigaki, a former finance minister, favors an increase in the consumption tax in order to pay off some of Japan's vast national debt.

While the election results were a bit surprising, and uncertainty will surely reign in Japan in the weeks just ahead—the change appears to be largely anticipated by markets and not an earth-shattering event. It's best to remain vigilant though, as pro-market LDP reforms appear to be in peril at the moment.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.