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The world continued digesting last week’s major political earthquakes Monday, with the fallout from UK Prime Minister Boris Johnson’s resignation and the tragic assassination of former Japanese Prime Minister Shinzo Abe just two days before Sunday’s upper house’s election. We have seen a ton of speculation as to how these events will potentially affect economic policy in the months to come, and while it might feel trivial to focus on this aspect—particularly in Japan—rather than the gravity of the events, markets are pretty laser focused on policy, not the social and human angles. So let us look at the latest happenings through that lens.
The Race to Replace Johnson Takes Shape
When we examined the latest kerfuffle over Johnson’s leadership last Wednesday, we remarked that there was every chance he would be out of a job by the time you were sipping your Thursday morning coffee. And so it went, with Johnson announcing midday UK time that the Conservative Party would shortly hold a leadership contest and he would stay on as caretaker prime minister (PM) until there was a new leader in place. Thus began one of the more raucous leadership contests in recent memory, with more mudslinging than you might think possible in a mere four days.
As it stands, there are 11 candidates in the mix officially, perhaps with more on the way before the nomination window closes at 6 PM British Summer Time Tuesday (that would be 10 AM PDT and 1 PM EDT). We will not take the time to name them all, chiefly because that list will be winnowed to two on July 21, following a series of debates and votes among Conservative Members of Parliament. The consensus view is that the top two will be former Chancellor of the Exchequer Rishi Sunak and whichever candidate the low-tax, traditional wing of the party determines has the best chance of beating him. At the moment, Foreign Secretary Liz Truss appears to have the inside track as she reportedly will get the backing of Commons Leader Jacob Rees-Mogg and Home Secretary Priti Patel, both of whom appeared to be backing off their own potential campaigns Monday. But Attorney General Suella Braverman and former Equalities Minister Kemi Badenoch also have strong support, and backroom deals could elevate any of the contenders. Regardless, by July 21 we will know the top two, and they will spend August campaigning nationwide. On September 5, the winner will be announced, and presuming they can win a confidence vote in Parliament, the UK will have a new PM.
As the contest plays out, there will be a ton of chatter about what the eventual winner will mean for UK stocks. If it goes as everyone envisions today, expect a ton of pieces arguing Sunak is an austerity candidate who raises taxes and whoever faces him is a tax-cutting marvel. Expect long treatises on what they mean for the ongoing cost-of-living crisis. We suggest taking it all with a heaping mountain of salt. One, politicians have a very, very long history of campaigning on one thing and then doing something else in office. PMs regularly U-turn on campaign manifestos. We recall the high expectations for Johnson and Sunak to cut taxes and use Brexit as an opportunity to cut red tape. Neither happened. So we are darned skeptical anyone can look at the result of this leadership challenge and pinpoint what it means for taxes, negotiations with the EU over the Northern Ireland Protocol, post-Brexit deregulation, spending, energy policy or what have you.
What matters more: We now have a timetable for falling uncertainty. In 10 days, the initial circus portion of the leadership contest will be over. A month and a half after that, there should be a new PM. In the following days they will pick a new cabinet. Labour will lobby hard for a snap election, and it likely won’t take long to become clear whether the new leader accedes. Then, presuming they choose to serve out the rest of this term, they will get down to brass tacks and discover how difficult it will be to push legislation through this very divided party. In other words, all signs point to gridlock.
That is a fine outcome for UK stocks, in our view. As we are already seeing with the energy windfall profits tax, gridlock waters down contentious legislation. Sometimes it stops bills entirely. Initially, the tax was to apply to all parts of the sector, including utilities. The government ditched that part of the tax Monday amid fierce opposition from that industry, which has endured dozens of bankruptcies since the household energy price cap took effect. It looks increasingly likely that oil companies’ warnings about the tax killing investment will chip away at it further. As gridlock chips similarly at other bills, it reduces uncertainty and makes risk-taking attractive, which stocks like just fine.
What the Focus on Constitutional Revision Misses in Japan
In the wake of his tragic assassination—and, as widely expected—the late Shinzo Abe’s Liberal Democratic Party (LDP) and its coalition partner, Komeito, took the vast majority of seats up for election on Sunday. That gives them a super majority in both houses of the Diet[i] and, in the wake of Abe’s death, most focus is on what this means for the revision of Japan’s constitution. Amending Article 9, which renounced the right to warfare and building a standing military, was Abe’s lifelong ambition, and the current LDP leadership—including current PM Fumio Kishida—vowed to press forward in Abe’s memory and see it through. Given constitutional amendment requires a two-thirds vote in both chambers and a popular referendum, a lot of observers are treating the revision as a done deal and trying to size up what it means for international relations in the 21st century and how that will ripple through Japan’s economic ties globally. We are also seeing a lot of people couch Abe’s free trade push in this light.
This is obviously a very delicate sociological issue in Japan, especially given the constitution and Article 9’s background. But we are very confused by the amount of attention paid to it in economic circles. For one, it isn’t clear to us that the likelihood of revision actually increased over the weekend, given Komeito is a pacifist party that has paid only the loosest of lip service to discussing constitutional amendment. It softened its position a little bit after Vladimir Putin invaded Ukraine, but not by much. It also favors amending Articles 72 or 73 of the constitution to enshrine the legality of the Self Defense Force in law, not Article 9, which may seem semantic but could be a very big roadblock. Lastly, the LDP is actually a loose confederation of factions that, in other countries, would be separate political parties, and some are more enthusiastic about revision than others. Abe had unbelievably high political capital and still couldn’t get it through—it isn’t certain that Kishida can ride the wave of posthumous affection for the fallen leader to complete the mission.
But also, people are wrongly tying constitutional amendment up with Abenomics—the three-part strategy of (alleged) monetary easing, fiscal stimulus and economic reform that Abe spearheaded and Kishida has positioned himself as caretaker of. They are linked, but not in the way people are arguing retrospectively. As we wrote numerous times during Abe’s tenure, while he reportedly viewed economic revitalization as key to garnering support for constitutional revision—and reforms as key to that revitalization—he repeatedly put the cart before the horse, trying to push an amendment forward before reforms were complete. Every time, it drained his political capital and reforms stalled out. Then he would get out of the rough patch, get back on the economic reform train, get a little more done, then push constitutional change again, lather, rinse, repeat. It seems to us the LDP is now getting caught up in this same cycle, and the more attention constitutional revision gobbles up, the less attention economic reform will get, which will likely dash renewed hopes for a revitalized Japan, Inc.
Yet Abe did manage to pass some reforms that, though short of what he initially proposed, are now starting to bear fruit. Completing the privatization of Japan Post, which had stalled after Junichiro Koizumi left office in 2006, was a major win. So was getting the corporate tax rate down below 30%, making Japan more competitive with the rest of the world. The recent wave of corporate mergers owes in part to Abe’s corporate governance reforms. So does the appointment of two activist investors to a major corporation, which would have been unthinkable a decade ago. The landscape won’t change overnight, but the framework is in place for markets to force companies to get more competitive by breaking the cross-shareholdings that preserve conflicts of interest and thwart competition. These aren’t the sort of developments that qualify as cyclical market drivers, but the long-term structural backdrop has become somewhat more favorable over the past decade.
And on a personal note, as stated at the outset of this article, we take a strict neutral, non-partisan approach when covering politics. But we are also human and will occasionally develop a personal fondness for some of the personalities we cover, and we found covering Abe for over a decade to be just plain delightful. He had grit and an infectious grin, he made us laugh and he will be missed.
[i] Which, despite what you may have heard from American TV pundits these past few days, is not pronounced like the word for a meal plan.
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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.