Japan’s GDP for the third calendar quarter of 2015 showed weakness, much like the consensus expectation, but once again, this kind of negative result should not cause much concern at all for equity investors. Indeed, there were some good signs in the data, with personal consumption rising above consensus expectations and net exports rising quite smartly, which indicate a GDP rebound in the coming quarters.
As always, there are important things to know about GDP statistics in Japan:
These statistics are often heavily revised and it would not be surprising if the most recent quarter was revised up, especially as there were several anomalies in the data.
Firstly, real (inflation adjusted) inventories fell sharply, and if they had been flat, GDP would have actually grown a quarter-on-quarter, seasonally adjusted annualized rate of 1.1%. Note that Japan has reduced real inventories for 23 of the 27 quarters since 2009 began, equating to a ¥55 trillion (about $550 billion) reduction in accumulated unit inventories since then, while the economy has meanwhile expanded 5%. It seems that Japan doesn’t have any inventories at all by this measure. So, this factor clearly understates GDP growth in our view and by comparison, the U.S. has boosted real inventories by $812 billion over this period with GDP rising 12% despite utilizing similar technology to improve the efficiency of inventories.
Secondly, a major anomaly was the "discrepancy factor" (the difference between the sum of the real components and total real GDP) which remains at a very large negative number and indicates that GDP is likely understated.
Thirdly, GDP statistics have no correlation with corporate profits in Japan. As our Evolving Markets reports have long-shown, despite lackluster GDP, Japanese corporate profits have surged during the last 10 years, with the trend clearly continuing in 2015, evidenced by profit margins at historical highs.
Of course, the weaker yen played some role in this recent trend, but service sector profits have been especially strong, which indicates that the economy is not as poor as the statistics suggest. Corporate governance improvements are also obviously a key factor to profit growth in Japan, greatly outweighing the effect of any economic softness and we expect this factor to continue, as it has now become deeply engrained in corporate culture.
As for the outlook, the Bloomberg consensus is for a rebound in GDP growth in the next two quarters, but the trajectory of growth has indeed been lowered, so we need to reduce our CY15 estimate to 0.7% from 1.0% (vs. the Bloomberg consensus of 0.6%), with 3.1% quarter-on-quarter, seasonally adjusted annualized growth estimated in the current quarter. Within this, we expect:
1. real inventories to rise to positive quarterly figures;
2. the discrepancy factor to be reduced;
3. personal consumption to rebound more strongly in the 4Q; and
4. net exports to decline mildly after their sharp 3Q increase;
The consensus estimate for CY16 growth is 1.1%, which may seem meager, but it is slightly above Japan’s natural growth rate.
In sum, as has long been our view, disappointing economic data should not worry investors in Japanese risk assets very much at all; indeed, TOPIX, driven by strongly rising profits, has risen quite smartly over the past year despite the weak GDP data, thus confounding those who concentrate too much on the macro-data.
Moreover, TOPIX has outperformed global equities this year in dollar terms; yet, not only are equity valuations still much lower in Japan than the U.S. and Europe, but earnings growth remains higher. Meanwhile, for Japanese investors, the relative outperformance of equities vs. other domestic assets has been crystal clear for several years and coupled with incentives created by Abenomics, an “equity culture” is finally flourishing, which should support the equity market in the years ahead and in turn support domestic economic growth via the wealth effect.
John Vail is chief global strategist at Nikko Asset Management.