As international investors begin to come back to the Japanese Stock Market one wonders if the country is economically truly on the mend? On July 28th the Nikkei Stock Average hit another 6 month high. The increase was backed by solid earnings from a number of leading industrial companies. There are an number of investors that are encouraged by this despite the growing deviation between the performance of the stock market and the domestic economy of Japan.
What is happening in Japan? The domestic economy is not in reality doing that well. In addition, the increase in the national sales tax from 5% to 8% starting April 01, of this year has become a new burden for the sputtering Japanese economy.
Yet a number of Japanese companies are doing well in the international arena. This is because these companies conduct business and make sales that are not dependent on the health of the domestic economy.
Corporate Headquarters of Honda
The Japanese based company Honda for example, is a case in point. At the end of July the company lifted its full year sales and profit forecasts. The optimism of the corporate leaders are based on the hope that new models would allow the company the ability to do well in North America. This area is their largest market. The new sales allowed the company to post an increase of 20% in profits.
Japanese auto maker Nissan was able to report a first business quarter increase in profits of 37%. This was a result of increased sales in North America, Europe and China. Inside Japan itself auto sales from the company actually declined during this period.
Hybrid Toyota Prius
Toyota which fell from the 8th to the 9th largest company in the world was able to boast earnings of $18.2 billion USD (United States Dollar) last year. The company was able to report an increase in earnings of 4.6% reinforced by growth in the United States, Europe, and China. Sales in the once hot emerging markets of South America and Southeast Asia have slowed considerably.
Isuzu Motors was also able to report profits exceeding forecasts due to increased sales abroad.
Shares in Fanuc jumped between 5% and 6% after the company stated that net profits for the company doubled in the second business quarter of 2014. This Japanese maker of industrial robots expects sales to increase 32% in the current fiscal year. Again the growth will comes from demand in Asia and Europe not domestically.
The question investors are asking is can this growth continue as the Japanese yen stops falling in value?
New Honda Model
Although Japanese manufacturers had made gains in a number of industries due to sales in the first quarter how long will this continue. Economic expansion in the developed world has not been impressive in 2014.
The Japanese government is continuing reforms that are meant to assist companies that are following an aggressive growth strategy. Prime Minister Shinzo Abe is attempting to restore business confidence that was somewhat diminished with the introduction of the new national sales tax rate. He has announced new measures that will hopefully help corporate organization and performance. The Third Arrow as labeled by the government is a move towards extensive structural reform.
The negative effects of the higher tax have not been as drastic as feared but they are still significant. It is important to note that wages in Japan after adjusted for inflation have continued to fall. It is also true that inflation is also slowing despite governmental efforts to expand the money supply.
Exports, the main engine of growth in Japan today is still struggling, despite the recent bout of good news.
Toyota Corolla Over 40 Million Sold World Wide
Investors should consider despite the recent gains in Japanese stocks that Japan itself is not a good environment for opening and growing a business.
One therefore must question how much can the Nikkei rise when there is no real wage growth and there is an absence of new business openings. The domestic market is continue to stagnate. Without a return of strong domestic demand, the growth in the Japanese stock market cannot continue to rise. Growth dependent on exports alone, will not be possible in the present international economic environment.
However, it can be said that the stock market in Japan remains one of the cheapest markets in the world.
Ticket Board of Tokyo Stock Exchange
The demand for Japanese equities in the domestic market has increased which will provide some support to the Japanese stock market. This alone though, will not be enough to keep the expansion going. The main buyers so far have been companies buying back their own shares and public pension funds. Retirement funds are increasing their exposure in a desperate attempt to raise returns for the rapidly aging Japanese population.
Although there has been a small bounce in retail sales overall, construction in new housing is still falling.
One policy change that may actually make a difference is the government plan to cut the corporate tax rate to a level that more closely resembles the rate in other parts of Asia and Europe. Lower corporate tax rates will stimulate investment and growth. The present rate of just above 35% is with the United States the highest in the developed world. The new rate will be just below 30% but some are calling for reductions to 25%. This is the rate that exists in South Korea and many nations in Europe.
Some will argue that a corporate tax cut will not be as significant as one might expect since only 1/3 of Japanese companies actually pay a tax on profits. That is short sighted. A lower tax rate will make a difference in future investment decisions. It is also the way Japan will be able to ramp up much needed foreign investments.
Tokyo Stock Exchange
The reform might also be helpful in working to eliminate the many impairments in the current corporate tax code. The government has used exemptions, deductions, credits and other loop holes to favor certain industries over others. Having the government pick winners and users often ends to economic distortions and inefficient allocation of financial resources.
The present Japanese tax code favors larger corporations because they are more effective in the lobbying of government officials. These companies are not in favor of tax reform but would support an overall rate cut.
Smaller companies end up paying a disproportionate burden of the corporate tax because they are less able to influence government officials. They want rate cuts along side reforms, to better equalize the business playing field.
Tax reforms and corporate rate cuts may be the best way to encourage more investment as it seems other reforms towards free trade, immigration and labor improvements have become bogged down in the usual manner of Japanese politics.
Japanese Currency, The Yen
It is clear something must be done to move the domestic Japanese economy forward. The massive program of quantitative easing worth $1.4 trillion announced this spring will double the country’s money supply. The results are yet to be determined.
The expansive monetary policy is a bold, although financially dangerous move. It is attempting to return the economy to growth and combat the deflation that has gripped the Japanese economy for a decade and more. The policy will devalue the yen which will help Japanese exports. But it will of course slow imports overall, and make needed energy importations more expensive. Given that Japanese industry is quite dependent on energy imports and other commodities from abroad, this will impact the business world in Japan along with consumers there.
Toyota Corporate Headquarters
The GDP (Gross Domestic Product) of Japan tells the story. The economy contracted -5.5% in 2009 but recovered with a rate of 4.5% in 2010. Since then, the Japanese economy has stagnated. In 2011 the economy contracted again by -0.6% and experienced growth of just 1.4% in 2012. The rate for 2013 was only 1.2% in 2013 and is projected to only grow 1.1% in 2014.
This writer suggests that selective investments can be made in some sectors of the Japanese economy that deal mostly with the export market. However, slowing growth elsewhere in the developed world will eventually limit the growth in these markets.
Honda Insight
An investor might be better served in shorting stocks in the Japanese markets. Although stocks may seem undervalued it is because the economy at large is showing little real growth. This is unlikely to change in the near term, and possibly the long term as well.
A number of factors including a rapidly aging population will be working against a revival of Japan’s economy. Rising entitlement and medical costs associated with these demographic changes will hamper efforts to jump start the economy as consumer demand for new products and services decline (outside the medical sector). Travelers and tourists to Japan will soon notice the changes to the population of this island nation.
Japan will continue to remain a difficult place to make a long term investment unless drastic reforms are enacted. Despite the claims of the government there has been a slowdown in the movement to reform and restructure the economy. Rhetoric alone will not achieve the desired outcomes in Japan.