Market Memo: The sun's rising again in Japan
Lost amid all the worries of late about the eurozone, China and a slow U.S. economy has been a relatively upbeat story about Japan. It now ranks among our global equity investment team’s favorite countries—we’ve doubled exposure in the past year—on an improving economic and earnings outlook; very attractive valuations; and Japan’s position as a substantial supplier to China and the rest of Asia. Additionally, because of the increasingly intertwined relationship between U.S. manufacturers and their Japanese suppliers and partners, U.S. manufacturing’s renaissance is serving as a strong positive for Japanese companies’ profit margins.
The international team estimates Japan’s inflation-adjusted GDP will grow 2.5% this year and 1.4% in 2013, abetted by rising internal demand and new growth policies in China. Such growth may not seem like a lot, but it’s significantly above the 0.75% annualized pace of the past 10 years and, perhaps more noteworthy, more than ample to support earnings growth among Japanese corporations used to dealing with little if any economic growth at home.
Internally, Japan is benefitting from a post-tsunami rebuild that didn’t get into full swing until this year, and, ironically, from recently adopted consumption tax increases. Because the tax increases don’t start to kick in until 2014 and don’t become fully effective until 2015, consumers and businesses are expected to front-load domestic purchases into this year and 2013 to avoid the higher tax bite. It also helps that Japanese businesses are feeling more optimistic, which bodes well for future business investment. The Bank of Japan’s most recent quarterly survey of business conditions showed sentiment among manufacturers rising for the first time in three quarters and, among service firms, hitting a four-year high.
China offers a lift
Externally, Japan should capitalize if China’s economy picks up, as we believe it will, now that Chinese authorities are less concerned about inflation and more concerned about promoting growth. China’s central bank has been moving more aggressively on monetary easing, and China has adopted a new five-year growth plan aimed at boosting domestic investment and consumption, and improving health care. Such pro-growth measures would be positive for several major Japanese exporters, which tend to be of higher quality than their Chinese peers, including Nidec, which generates more than a fifth of its revenue through sales to China of specialty motors used in everything from power steering to electric appliances; Hitachi, which projects 60%+ sales growth in China through 2015 through the sale of such infrastructure-related products as generators and water-treatment systems; and pharmaceutical firms Astellas and Takeda, the latter of which expects to double its sales force in China the next two years.
Given this improving macro outlook and spring’s steep sell-off in the Nikkei, valuations for many Japanese companies are attractive. We think year-over-year earnings growth among major Japanese companies will exceed 25% this year, more than reversing last year’s decline, as this improving economic environment and Japanese companies’ low-debt balance sheets allow more of the top-line growth flow to the bottom line through higher profitability. It is an underappreciated story for an underappreciated country still wrestling with a two-decades-long struggle to overcome a massive asset-price collapse. Japan may never again be the shining economic star it once was, but like any good book that never makes it atop the best-sellers, it’s still worth a look.