By Robert Rountree
New orders for Japan’s manufacturing industry are surging, but investors would not seem to have noticed – so far.
Since June 2014, order books have expanded by more than 25%, with a near-vertical rise since January this year. The puzzle is the lack of attention this has attracted from the investment community.
One explanation for this apparent absence of interest to date may be that investors are distracted by events in China and in the United States, especially recently. Another, more intriguing, answer to this puzzle is that the strength of manufacturing orders has been disguised by the weakness – of non-manufacturing orders that dominated most of the first half year.
Unsurprisingly, non-manufacturing orders themselves surged ahead of the imposition of the new sales tax in April last year. Equally unsurprisingly, they fell back afterwards, and their fall brought down the overall “headline” order figures, concealing the strong rebound in manufacturing orders.
While manufacturing orders were also affected by the sales-tax rise, this was to a much lesser extent than the impact felt by non-manufacturing businesses. Now, with non-manufacturing orders rising once more, we could well see some strong headline figures during the next few months.
So far, the underlying surge in manufacturing orders has escaped the notice of many analysts and investors, but a recent uptick in sales forecasts suggests that some, at least, are beginning to notice the bigger picture.
If growth in orders has been overlooked, and sales forecasts consequently lower in general than they ought to have been, then one would expect corporate profits to have been underestimated. Indeed, this seems to be exactly what has been happening. Actual announcements of corporate profits have exceeded analysts’ consensus profit forecasts for ten straight quarters, from the three months October-December 2012 to the period January-March 2015.
With the reporting season now underway, it would be surprising were there not to be further profit out-performance as the results come in.
Encouragingly, the upswing in orders would seem to be driven largely by home-market demand. Given that domestic activity accounts for about 88 per cent of Japan’s economy, the resurgence of orders from within Japan is likely to foretell more general good economic news.
Nor is the home market likely to have to shoulder the corporate recovery alone for too long. Exports have yet to respond to what is by any standards a ferociously competitive value for the yen, but it can be only a matter of time. The currency is at a 40-year low, and is about 30 per cent lower on its trade-weighted index than it was ten years ago.
Furthermore, those fearing that the downside of the more competitive yen may be an increase in currency-related losses can take reassurance from Haruhiko Kuroda, Governor of the Bank of Japan, who said in June that he did not expect the yen to weaken further in trade-weighted terms.
In all, the underlying picture for Japanese corporate strength is very much healthier than is generally credited, although, as mentioned above, some are beginning to take notice of the good news. Significantly, growth is forecast to manifest itself in rising corporate sales and, ultimately higher profits – precisely those areas that will be of most benefit to investors.
Despite this partial awareness that the Japan “story” is enjoying a hot streak, investors in the Japanese market are still in the early stages of pricing in the bullish outlook for orders, with the result that Japanese equities remain attractive bordering on fair value, in stark contrast to the US, where equities are very much in the “expensive” zone.
In short, despite August’s market turmoil, Japan looks set for a good second half of the year.
Robert Rountree is global strategist at Eastspring Investments
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