The main difficulty currently confronting Japan's stock market is the difference between the coun...
The main difficulty currently confronting Japan's stock market is the difference between the country's real and nominal economies. Encouragingly, Japan's real GDP for the second quarter was up 0.6% quarter-on-quarter, outperforming expectations of 0.2%.
However, both real consumer spending and real capital spending were down in nominal terms, while the GDP deflator has been negative since the beginning of 1998. Real growth is all well and good, but if prices are falling faster than volume output expands, it is still difficult for companies to grow profits.
Japan's economy remains mainly export-driven. Recent attempts to keep the yen at about 120 to a weaker dollar seem to have succeeded, and its weakening on a trade-weighted basis benefits Japan's export earnings. Nevertheless, Japanese exports are now flat year-on-year.
We continue to believe it is highly unlikely that the economy will accelerate sufficiently to achieve real growth much above 1.5% for this financial year.
Such an increase would mean nominal GDP growth of about zero ' in line with Japanese companies' expectations of flat sales ' and profits growth of low double digits, achieved through cost-cutting.
Although cutbacks finally seem to have become part of Japanese corporate life, one area which has not been controlled is core costs: its ratio to sales has not fallen for one single year over the last decade.
Moreover, if this year's fall in unemployment and rise in wages is indicative, cost-cutting seems unlikely to continue at last year's pace.
The greater sense of realism which has crept into the stock market over the last month looks very appropriate. It is difficult to understand how the Japanese stock market can be made to look as cheap as some claim.
On earnings per share, which is no longer depressed by the accounting one-offs of the last few years, the forward P/E is 30 times, which hardly looks cheap for 10%-15% earnings growth.
However, this does not mean there are not cheap shares available for investors who know where to look. There are still growth areas where Japan continues to excel. The country has been a model for the expansion of the global mobile phone industry; for example, virtually all of this year's Japanese mobile phones come equipped with camera modules as a matter of course.
The growth in Liquid Crystal Display use and in components related to increasingly sophisticated mobile phones, should benefit relevant Japanese manufacturers.
We would advise investors in Japan to steer a middle ground between pessimism and optimism. The reality is that although some fundamentals in Japan are not improving, some are, and positives are increasing faster than negatives.
Our belief in the economy's ongoing albeit decelerating growth and in corporate profits ensures that we are not bearish, although the market's full valuation and Japan's persistent structural impediments to long-term growth mean we are not particularly bullish either.
Recent GDP growth above expectations.
Electronics expertise benefits manufacturers.
Corporate profits remain evident.
Paul Bruns and Elaine Parkes
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