Japan's Double Dip

 |  Includes: EWJ, FXY
by: Darrel Whitten

Foreign investor interest in Japan perked up as Japan's real GDP grew 3.9% annualized in the July-September quarter versus a consensus 0f 2.5% growth. Until Q3, Japan's economy seemed to be pulling out from an historically deep recession in 2009, but what apparently looks like good news really isn't.

On November 16, Japan's Nikkei carried a survey of domestic economists' views of Japan's GDP over the next couple of quarters. The bottom line is that the consensus is for a double dip in Japan's real GDP of some 1.7% annualized, with the most bearish (Daiwa Research) seeing a 3.8% dip. Further, the consensus is for a weak 0.8% rebound from this dip in the first quarter of calendar 2011.

In terms of quarterly annualized growth rates, a graph of Japan's real GDP growth is beginning to look like a yo-yo. Real GDP growth in January-March 2010 beat expectations by surging 4.4%, while it Q2 growth significantly undershot consensus expectations by braking sharply to only 0.4% annualized in the April-June period, then beat market expectations by rising 3.9% annualized in Q3.

The slowdown in Q2 came from faltering export growth, while Q3 was boosted by government stimulus in the form of "eco" subsidies for consumer purchases of green cars as well as green consumer electronic products. As the subsidy program for green cars ended in September, domestic car sales tanked in tandem, and falling 23% year-on-year. Domestic car sales already plummeted to 4.88 million in fiscal 2009 from 7.8 million in fiscal 1990, and The Japan Automobile Dealers Association forecasts that the figure will fall to the 4.6 million level in fiscal 2020 due to the shrinking population and aging society.

Government-controlled cigarette sales also were a boost to convenience stores in advance of a big (40%) tax hike on cigarettes. After the tax hikes, cigarette sales plummeted nearly 70% YoY in October, and JT (Japan Tobacco) has lowered its FY2010 sales forecast to a 17.% decline for the year as a result, and same store sales at the convenience store chains dropped nearly 10% in October.

A similar eco point program for consumer electronics boosted sales of flat-panel TVs that can receive the new terrestrial digital broadcasts being introduced in Japan next year by 57% in 2009, and shipments continued growing at high two-digit rates in 2010. By the end of June this year, about half of the JPY526.7 billion yen worth of eco points for electric appliances were consumed, with flat-panel TVs commanding much of the money. This demand could well disappear as well as the eco-point rewards program for electronic appliances gradually winds down from December and terminates at the end of March 2011.

In other words, all that Japan has accomplished with the eco subsidy programs is to front-load consumption without increasing the total consumption pie. When the subsidies go, so does domestic demand. The Nikkei's NEEDs economic model shows real and nominal GDP in FY2010 to next March and FY2011 by 2.3% and only 0.6% respectively, followed by 1.0% and -0.2% growth respectively in FY2011.

Corporate Profit Recovery to Wane as Well

Overseas investors have also observed that Japanese corporate profits were holding up better than expected. That was true as far as the first half of fiscal 2010 to September, as ordinary profits for all industries for the fiscal year to March 2011 are now expected to grow 47% YoY versus a 39% growth forecast several months ago--but all of the upside came from first-half profits, which of course have long since been discounted in stock prices.

Looking at YoY growth in the second-half alone, however, manufacturing sector ordinary profit will be down about 10% YoY on current estimates, while the non-manufacturing sector will show about 10% YoY growth.

Japanese Stock Prices and the Double Dip

Despite all the concern about a double dip slowdown in the US, the S&P 500 is still up 7% YTD on the Fed's QE, while Japan's Nikkei 225 is down some 9% despite Japan's half-hearted intervention in the exchange market and the BOJ's reinstatement of QE. Looking at the yo-yo GDP numbers and the second half erosion of Japan's corporate profit recovery, it is easy to see why Japanese stock prices have virtually ignored Japan's recovery so far.

Disclosure: No positions