Although there are still concerns about deflation and nominal growth remains flat, the Japanese econ...
Although there are still concerns about deflation and nominal growth remains flat, the Japanese economy has been showing signs of improvement. Companies have been cutting costs and profits have been recovering, the export industry has been picking up and household spending has been positive.
Denis Clough, head of Pan-Asian equities and manager of the Tokyo fund at Schroders, says: "Success in cost-cutting, efficiency improvements and profit growth was evident in the raft of Japanese year-end company reports released in the second quarter - despite the weak economic outlook."
According to Clough, the improvement has been in the area of exports and capital investment. Companies have been exporting to other parts of Asia, especially China. China has gone through a period of rapid growth.
The export of capital goods from Japan to China has grown as China builds up its manufacturing base. This has been led by the export side of the economy, helped by the weak yen and strong demand from China, with some feed through to domestic demand via a pick-up in jobs and good summer bonuses.
An increase in consumer spending in the US is also helping Japan. Car and electrical manufacturers are increasing production and hiring more workers due to a rise in exports to the US.
Stephen Mitchell, head of Japanese Equities at JP Morgan Fleming, says: "While the economic environment in Japan remains difficult and policy remains inadequate, the bottom-up restructuring taking place in Japan is having a meaningful impact on corporate profitability. Operating earnings rose by 26% in the financial year to March 2003, despite just a 1% rise in sales. This trend is continuing, and we expect operating margins in Japan to reach a new high this year, thanks to further cost-cutting and improving top-line revenue growth thanks to strong Asian demand.
"This is reflected particularly in strong order book growth for basic industries such as steel, machinery and shipping. These industries are seeing their strongest profit cycle for a long time and offer attractive investment opportunities for the first time in many years."
But although the Japanese economy is performing slightly better, Clough warns nominal growth remains flat which suggests there is still a tough environment for companies.
He says although the savings rate has dropped, there are still worries about deflation. Companies are still restructuring and the pain is not over yet. It is unrealistic to be too optimistic.
According to Clough, the government has been putting up taxes and cutting its own spending. Social security payments have gone up and the government still has a big deficit.
Miki Sugimoto, fund manager of the Newton Japan fund, says: "The Bank of Japan modestly upgraded its economic assessment in July. The improvement in its outlook came largely as a result of diminished global economic uncertainty and the containment of Sars in parts of Asia. Japanese unemployment fell in June for the first time in four months. Household spending year-on-year was positive in June for the first time since the beginning of 2003. The same positive factors were behind an improvement in business sentiment shown by the latest quarterly Tankan report [a quarterly survey on business sentiment]. However, the Bank of Japan acknowledged the prospects for improved economic growth still largely depend on events in the US and other export markets - although recent economic indicators have indicated a strong pick-up in activity in the US."
He thinks Japan should benefit from a cyclical upturn in the world economy. Although domestic demand is still not strong, positive operating margins are coming through. Compared to Europe and the US, market valuations are low on asset and sales multiples, but high on earnings multiples.
Mitchell, says: "The May industrial product numbers were ahead of consensus forecasts and the second-quarter GDP report came in at a much better-than-expected +0.6%.
"However, despite the pick up in economic activity, the economy continues to be blighted by deflation, keeping nominal growth low and making corporate pricing power very weak.
"Therefore there is a need for companies to look to overseas markets to increase margins and profitability, increasing the already - excessive dependence that Japan has on export rather than domestic demand."
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