The Bank of Japan Tankan supports a 2014 Japanese equity rally (Part 1 of 10)
Sentiment is back to 2007 levels
This series examines the key economic indicators in the Bank of Japan’s “beige book,” as we call it in the USA in the case of our Federal Reserve Bank. In Japan, the Bank of Japan refers to this survey as its Tankan (Short-term Economic Survey).
The below graph reflects the dramatic improvement in business conditions in Japan since the 2008 crisis. Remember that Japan’s new Prime Minister, Shinzo Abe, was elected in November 2012, with a key economic mandate to get Japan out of its post-1990 deflationary spiral. Since that time, large manufacturing companies (the red line) have rebounded strongly, as Japan’s new Prime Minister has begun implementing his “three arrows” strategy to revitalize the Japanese economy—monetary policy, fiscal policy, and regulatory restructuring. As a result of the aggressive monetary and fiscal policies being employed, the Japanese yen has weakened 30% since late 2012 and has made a major contribution to the growth in profitability among Japan’s exporting companies. This series takes a deeper view of the economic data so that investors will have a clearer idea as to whether or not long-term growth prospects will outweigh this single quarter of weak data.
Calendar 4th quarter GDP is weaker than expected
Despite the additional positive trends noted in this series, readers should consider that Japan’s gross domestic product for the first calendar quarter of 2014 came in at a mere 1.0%—far below 2.8% estimates. On an annualized basis, public demand grew 0.8% over the same quarter the prior year, while public demand (government spending) grew 0.9%. Private residential investment grew at an annualized 4.2%. Japan remains concerned that its January-through-March data will be significantly weaker, with Japan’s Cabinet Office estimating the next quarterly GDP growth number to fall from 1.0% to 0.7%. (Note that Japan’s fiscal year runs from April 1 through March 31, so the recent data is technically Japan’s third fiscal quarter GDP data, though it’s fourth quarter data on a calendar basis or according to U.S. convention).
Shocker: Non-manufacturing outpaces manufacturing
The above graph reflects the Nikkei Index (the dotted black line) lagging business sentiment recovery in Japan. While the weakening yen has supported the manufacturing sector’s profits and outlook (the red line), it’s also important to note that the non-manufacturing sector (the green line) has made a significant recovery, outpacing manufacturers on the recovery for the first time since the bubble economy burst in 1990. This points to a fairly broad-based recovery in Japan, though if the yen continues to weaken, it’s likely that Japanese manufacturers will continue to grow at the recent astronomical pace. This is great news for Japan’s investors.
To see how Japan’s fixed investment recovery is supporting the equity market and corporate profits, please see the next article in this series.
For an overview of the U.S. macroeconomic recovery that could support Japan’s export economy, please see 2014 US macro outlook: The crack in the debt ceiling.
Japan’s equity outlook
As 2014 progresses, investors could see a continued outperformance of the Wisdom Tree Japan Hedged (DXJ) and the iShares MSCI Japan ETF (EWJ) versus China’s iShares FTSE China 25 Index Fund (FXI) and Korea’s iShares MSCI South Korea Capped Index Fund (EWY). For further clarification as to why DXJ could outperform both EWJ and other Asian equity indices, please see Why Japanese ETFs outperform Chinese and Korean ETFs on “Abenomics.” Plus, as Japan pursues unprecedented monetary expansion and the U.S. Fed tapers its bond purchases, Japanese equities could also outperform broad U.S. equity indices, as reflected in the State Street Global Advisors S&P 500 SPDR (SPY), State Street Global Advisors Dow Jones Index SPDR (DIA), and Blackrock iShares S&P 500 Index (IVV). For more on how the U.S. Fed’s recent announcements could impact global equities, please see Will the Fed take a bite out of Apple?
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