Japan’s corporate earnings picture starting to look murky

Japan’s stock market has been in vogue for much of this year, supported by its attractive valuations, continued improvement in corporate governance, restructuring and improving shareholders returns. This said, we have had our doubts about the sustainability of overseas capital inflows into Japan’s highly economic sensitive equity market given the weak global economic backdrop. 

As we approach the end to the current earnings season, we have come away even more cautious about the medium-term earnings picture as YoY hurdle rates for further growth is likely to rise substantially from this quarter onwards. Indeed, unless the yen plummets further against other major currencies, the positive impact of the weak yen in flattering profits of multinationals and exporters will likely become more muted from here on. 

Meanwhile, anaemic end-demand from overseas remains a key issue on sales volumes and capacity utilisation rates, even if inventory adjustments in technology segments come to an end this year. With auto production rising rapidly as chip shortages become less problematic, we also see auto-related sales peaking by the year-end as post-Covid sales surge from better stocked showrooms start to slow down while incentives in the US are starting to creep higher. 

China’s slow economic recovery is another major issue which is already hurting sales of Japan’s capital goods exports. With global supply chains being recalibrated away from the region, Chinese demand for Japanese machinery, machine tools and factory automation may remain lacklustre in the near future. Moreover, Japan’s export restrictions of high-tech capital goods for semiconductor manufacturing which came into effect last month may also begin to hurt sales of related tools.

The persistently high interest rates in the US and the resultant regional banking woes which could hurt loan growth is another problem which is unlikely to go away anytime soon. Add to the mix, a more notable impact of climate change we are witnessing across the world, not to mention, the ongoing war in eastern Europe which could keep energy and food prices elevated, all leave us highly sceptical of further near-term gains in our market. 

With Japan wage growth being eaten away from rising core inflation, domestic consumption is also unlikely to grow meaningfully. With positive YoY impact of removing Covid restrictions on retail activity also starting to look less pronounced, much now depends on the ongoing boom in inbound tourism in Japan which has been partly supported by the weak yen which has made Japan a cheap destination to travel to. 

Indeed, China’s latest decision to allow group international tours to commence is one potential positive factor that could help sustain revenue growth in the service sector for the time being. However, beyond that, we think there is not much to get excited about as headwinds from weaker earnings picture leave Japan’s stock market’s upside looking fairly limited.