Japan, like the United States, is headed for recession. How long it will last and how deep it will bite is now the question.
One leads to the other. Nomura has changed its call and is anticipating a decline in Japanese gross domestic product in Q4 of this year and Q1 of next. That's largely as a result of a "shallow but long" recession in the United States, which will depress the sales of Japanese car companies and computer makers, in particular.
"Our downward revision for exports was particularly large," Nomura's Japan economics team explain. "However, we expect a recovery in inbound demand to offset some of the downward pressure," they add.
Japan has more scope to offset economic weakness than the United States, since it can still turn to fiscal stimulus without any fear of stoking price hikes. Inflation stands at 2.5% as of May, steady from the prior month. The government and central Bank of Japan have consistently failed to achieve their targeted 2% rate of inflation, so this summer's higher prices have in fact provided a welcome boost if the rate of price increases now plateaus.
Tax revenue in Japan looks set to come in at a higher level than expected. With price increases largely concentrated only in fuel and food, the government can afford to use the extra yen in its coffers on stimulatory spending, likely expanding existing plans and possibly introducing a second supplementary budget for the current fiscal year, which runs through March 2023.
Although the size of the economies in China and Japan mean two of the three largest economic engines rev in Asia, it is the direction of the United States that will still govern global growth. "Almost each time the U.S. economy has gone into recession since the end of the Second World War, the Japanese economy has followed suit," Nomura notes.
Recession is still likely rather than inevitable in both the United States and Japan. But rising U.S. interest rates, tightening monetary conditions, declining consumer confidence, and high prices make it more likely than not for the U.S. economy. Japan is highly likely to then follow suit. Real GDP in Japan is likely already declining by 2.2% as I write.
Japanese carmakers sell 18.1% of their exports into the United States, their leading source of sales, while 10.8% of Japanese computer exports sell into the U.S. economy. So those are the sectors most at risk in Japan.
In the case of Japan, companies will have the weak yen largely on their side in offsetting the worst effects. Japanese multinationals built their forecasts for the fiscal year ended in March on an exchange rate that was at least ¥10 out of date. Now they'll be factoring in the currency's quarter-century low point into their predictions for the year ahead.
Any share-price benefit should be telegraphed when they revise estimates. Companies with strong-yen assumptions tend to see their share prices peak on the day they release results confirming the currency effect, and decline thereafter. However, fast-moving investors could buy into earnings revisions based on currency effects before the yen rate is adjusted, and benefit from the runup before the companies release results.
Companies with strong-yen forecasts have already been outperforming in 2022, and are likely to continue to do so. The size of the currency discrepancy is particularly large this year. But only half of Japan's main exporters have adjusted their forex assumptions to even recognize the weakness of the yen.
The yen currently sits at ¥135.23 to the U.S. dollar. That's the weakest level since 1998, and pushed past recent episodes of weakness in 2015 and 2002, as I explained when the Japanese currency first broke the ¥135 barrier in mid-June.
That ¥135 barrier had been the resistance at other points of decline, at least in this century. The currency pushed out to ¥136.997 - ¥137 if you're rounding. But it is now refusing to budget back below ¥135 even when it strengthened again to that level on July 3, since then it has weakened again. Movements past ¥135 will suggest a persistent strengthening, and past ¥137 will see it move toward its next resistance level.
You'd have to go back to 1998 to find it at a weaker level to the U.S. dollar. Significantly weaker. It hit ¥147.63 on August 11, 1998, when Asia was reeling from the Asian financial crisis, and Japan had yet to recover from the bursting of its asset bubble earlier that decade.
Two "lost decades" followed suit, in which Japan found it impossible to break out of a cycle of deflation, a devastating pattern of persistent price declines. If we think high gas-pump prices and vegetable costs are painful in this period of inflation, we can console ourselves that we're not stuck in a deflationary cycle that encourages saving and avoiding spending, both at a corporate and personal level, because prices will only get cheaper next year. An economy in deflation grinds to a halt.
Many companies based their predictions for the year that ended in March, the traditional fiscal year end in Japan, on levels between ¥115 and ¥120 to the U.S. dollar. Missing that mark by a significant margin can drive millions through to the bottom line, with videogame maker Nintendo (NTDOF) and T:7974 benefitting to the tune of almost US$1 billion, as I outlined in a breakdown on that phenomenon.
Carmaker Toyota Motor (TM) , electronics house Panasonic Holdings (PCRFF) , camera-and-printer specialist Canon (CAJ) and entertainment group Sony (SONY) all also benefit to a similar degree.
Companies that import foreign-made components or that get the bulk of sales within Japan will suffer, however. That hurts companies such as the drinks giants Asahi Group Holdings (ASBRF) and Kirin Holdings (KNBWY) . While they make their beer for domestic sales within Japan, ironing out any currency effects, they import material for their cans and also must buy expensive fuel - Japan imports all its oil - for the energy-intensive process of shipping their bulky goods around the country. Convenience-store chain Lawson (LWWLY) must also pass along similar costs to customers who are already feeling the pinch in the household pocketbook.
Japanese stocks are suffering this summer, but only slightly. The Topix index, down 1.2% today, has fallen 4.3% in the last month. It's at similar levels to the start of 2021, much the same trend as you'd see in the S&P 500. But of course the S&P 500 is looking for the next leg down if the Fed gets more aggressive on interest rates, having lost 20.1% so far this year, a persistent pattern of decline at least through mid-June. The Topix is treading water, down 8.6% in 2022, and bouncing around off lows that it shows no sign of retesting.
Other companies worth watching for yen revisions including car component makers Denso (DNZOY) and T:6902 and Aisin (ASEKY) and T:7259, components maker Nidec (NJDCY) and T:6594, and the electronics makers Fujitsu (FJTSY) and T:6702, Kyocera (KYOCY) and T:6971, Mitsubishi Electric (MIELY) and T:6503, and Konica Minolta (KNCAY) T:4902.
Investors should watch for word of any currency adjustments - buying in before the companies adjust for this period of excessive yen weakness should reap rewards.
