BoJ's Tankan Surprises to Upside, Investment Implications

 |  Includes: EWJ, JEQ, JOF, JPXN, VPL
by: Steven Towns

The Bank of Japan's quarterly tankan or short-term economic survey for September was released earlier today in Japan. Results for business optimism among "large enterprises" were higher than expected, stoking investor sentiment as the Nikkei gained for the fourth-consecutive trading day -- its longest advance since early July.

The September tankan (html outline and pdf full report) key diffusion index reading for large enterprises came in at 24 versus 21 in June after what was expected to be an equal or slightly lower reading given recent mixed economic data. This is the highest mark in two years. Also, medium-sized enterprises increased by a point for a reading of 14, while small enterprises lost a point for a reading of 6.

For a better understanding, according to the AP, "The index measures the percentage of companies reporting that business conditions are better minus those reporting that conditions are worse." Interestingly enough, the BoJ's wording in its survey puts 62% of large manufacturing respondents in the "not so favorable" business outlook category. However, from the chart below, you'll see how negative business sentiment has been over the past 15+ post-bubble years and you can also see what effectively amounts to the failed recoveries along the way.

(click image to enlarge)

The tankan is loaded with data but one area the financial press has focused on is CAPEX by large manufacturers, which is forecast to remain robust. Likewise, planned CAPEX among all companies is at it highest level since 1990 according to WSJ reporting.

Separately, reports Japanese stocks notched their fourth quarterly gain in five quarters. The Nikkei 225 gained 4% on the quarter and the broader Topix increased by 1.5%. Overall, Japanese stocks have rallied nicely since Shinzo Abe took office as Prime Minister last week, succeeding Junichiro Koizumi. During Koizumi's 5 1/2 years in office the Topix gained 14% according to an Asahi Shimbun article. While this is figure may not seem remarkable, it is considering how far stocks fell when the market bottomed in 2003 as Koizumi oversaw banks disposing nonperforming loans and mass corporate restructuring. quoted a Daiwa SB Investments manager who said:

"Many companies kept their full-year profit forecasts unchanged in June, but the result of the Tankan may encourage companies to raise their projections at the announcement of their half-year earnings. The recent concern over economic slowdown was excessive."

There is some speculation that the latest tankan could prompt the BoJ to raise rates by the end of the year. I find this unlikely as do most economists responding to tankan data. The consensus seems to be the BoJ will raise rates for a second time since July by sometime next spring.

Another point worth mentioning is the weakness in the yen. This basically translates into strength for Japanese exporters and those companies with operations/sales overseas. From an investment perspective, it may be a good time to purchase Japanese stocks since (1) a BoJ rate hike should result in yen strength, (2) a further pause by the Fed or a rate cut would certainly result in yen strength, (3) a combination of a BoJ hike and Fed cut would likely result in a big move by the yen, (4) all of this means that foreigners purchasing Japanese ADRs, ETFs, and funds will see gains if anything, from the yen strengthening and lastly, (5) currency conversion profits will be substantial in some cases (6) resulting in some firms boosting quarterly and/or annual guidance.

iShares MSCI Japan Index ETF (NYSEARCA:EWJ) 1-year chart:

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Disclosure: I do not own shares of any companies mentioned in this article.