Japan's economy is sicker than expected, new data shows this week, with the economy contracting at an annualized rate of 6.3% in the December quarter. Even without factoring in the coronavirus scare, which threatens to disrupt this summer's Tokyo Olympics, it looks like the world's third-largest economy is now in a recession.
And we must factor in the coronavirus scare. Of the Japanese companies with operations in China, 87.1% suspended production in response to the emergency, the Nikkei reports, and 56.2% are experiencing continued disruption to their Chinese operations. Some 70 Japanese large-cap companies get at least 10% of their sales in China, according to Nomura.
There will also be disruption within Japan itself. Outside China, it is the country with the most coronavirus cases, the count currently at 621. While the vast majority of those have occurred on the Diamond Princess cruise ship, there are also signs of community-spread infections among the 79 other infections in Japan.
An 80-year-old woman died last Thursday in Kanagawa Prefecture southwest of Tokyo. She was the mother-in-law of a taxi driver who has also tested positive for the Covid-19 virus. No one is too sure which way the transmission spread between the two, or how they got infected. Here in Hong Kong, we've just had the second virus-linked fatality in the city.
Japanese shares suffered a two-day fall after Monday morning's gross domestic product data, with the Topix index of all major Tokyo shares down 2.4% through Tuesday's close. Even with a mild 0.4% rally on Wednesday, the Topix is down 4.3% since the extent of the coronavirus impact became clear on Jan. 22.
The poor sentiment was only compounded by the GDP figures. The Japanese economy slowed down far faster than the 3.7% drop anticipated in a Reuters poll, thanks to a worse-than-expected impact from an increase in the sales tax.
The quarterly drop was the worst since Q2 2014, the last time Japan increased its sales tax, which it is doing to cut into the country's huge fiscal deficit. It has the highest debt burden of any G20 nation. This sales-tax increase, from 8% to 10%, was expected to hurt less than the 2014 increase, when it went from 5% to 8%. But it's clear the impact has nevertheless been underestimated.
A Q1 economic decline seems assured, and may be worse than the December quarter. Japan will bear the heaviest burden of travel restrictions on Chinese tourists, resulting in US$1.3 billion in lost tourism revenue in this March quarter, according to a preliminary forecast from the International Civil Aviation Organization, a United Nations agency. Thailand runs a narrow second, with US$1.2 billion in lost travel-related business due to the virus. Airlines will suffer US$4 billion to US$5 billion in lost revenue globally, the ICAO predicts.
A number of studies such as this 2014 McGill University research have shown that we remember bad news far better than good, the so-called "negativity bias." This has not really applied on the economic front this week in Asia, because there was only bad news. At least, that's what I recall.
Although Singapore raised its Q4 growth from 0.8% to 1%, the Lion City has cut its forecast for full-year growth. It may even turn negative, with Singapore citing a range of -0.5% to 1.5% for 2020.
Thailand, meanwhile, said its economy grew at the slowest rate for five years in 2019. It has forecast growth of 1.5% to 2.3% for this year, bracing for that US$1.2 billion tourism hit. South Korea will likely lower its forecast for 2020 growth, and Moody's has just slashed its own forecast for Korea from 2.1% to 1.9% due to Covid-19 concerns.
For Japan, the sales tax, a number of typhoons and the U.S. trade wars all hurt Q4 consumption. U.S. President Donald Trump has at times attacked Japan, particularly over auto sales, and the friction with China also disrupts many Japanese companies with operations there.
To make matters worse, Honda Motor (HMC) and Nissan Motor (NSANY) have large joint-venture auto factories in Wuhan, the center of China's car trade. Nissan is attempting to resume China production outside Hubei, but isn't sure when the Wuhan plant will resume.
Renault (RNLSY) and Peugeot-Citroen (PUGOY) also both have factories in Wuhan, as do the Chinese automakers SAIC Motor SH:600104, Dongfeng Motor Group (DNFGY) and Geely Automobile Holdings (GELYY) . Around them are thousands of suppliers and smaller autoparts manufacturers.
Nissan faces the greatest challenges. It is still contending with the fallout over fugitive ex-chairman Carlos Ghosn. The company last week posted its first quarterly loss for almost a decade, and cut its full-year profit forecast by 43%.
Yet investors outside Asia are blithely carrying on like little of import is happening in Asia. European shares have this week hit an all-time high; the S&P 500 and Nasdaq are also setting and resetting records.
It is not yet clear what will puncture this bubble. Maybe the warnings from global health-care experts, who are instructing that we should be abandoning efforts to quarantine this virus and focusing instead on treatment and early detection, may finally sink in.
For Japan, investors are at least favoring defensive stocks and low-volatility holdings.
Property companies and drugmakers have held up the best, both sectors up 4.4% since January 22, while utilities have advanced 2.0%. All three are defensive plays, with pharmaceuticals having the added advantage of likely business out of the coronavirus crisis.
Growth stocks were the star performers in Japan at the start of the year. But quantitative analysis of "factor performance" by Nomura shows that the pattern has completely reversed due to the Wuhan virus. Growth has been abandoned, with investors taking refuge in low-vol stocks.
Electrical appliance makers, and makers of high-precision instruments, stand to suffer the most, Nomura anticipates, with operating profits likely to fall 4.7%. Raw materials and chemicals will also suffer thanks to bottlenecks in supply and lower demand. Of course, retailers and restaurants will be hit both by the absence of Chinese consumers, who account for 37% of all tourism spending in Japan, as well as any reduction in local demand.
Nomura does not believe the negative impacts of the coronavirus are yet accounted for by the market. If the coronavirus disruption in terms of demand and supply chain disruption dents the Japanese economy by another 0.5% in the March quarter, profits for that quarter will by dealt an 8% blow. That would reduce full-year earnings by 2%, and should depress Japanese stocks by about 2%.
I'd advise investors in other parts of the world to run similar numbers. Markets in the West are not being realistic about the long-running and far-reaching impacts of a major disruption to the "factory to the world." Even if the virus itself isn't making itself felt where you are, the impact on companies soon will.
Super-large-cap tech stocks have been the stellar U.S. performers, particularly Microsoft (MSFT) and Amazon (AMZN) . That's partly thanks to earnings, partly thanks to their presumed insulation from the worst of the virus. But this may be masking greater weakness among even U.S. equities.
"The sharp rebound by U.S. stocks may seem somewhat surprising, but could also be interpreted to mean that investors are at the mercy of an unpredictable infectious disease," Nomura's team notes.