Japan Manufacturing Exodus âLarge' Cause for Trade Concern
Comment of the Day

January 25 2012

Commentary by Eoin Treacy

Japan Manufacturing Exodus âLarge' Cause for Trade Concern

This article by Cheng Herng Shinn for Bloomberg may be of interest to subscribers. Here is a section:
Japan's exports fell for a third consecutive month in December, capping the first annual trade deficit since 1980.

Shipments dropped 8 percent last month from a year earlier, the Ministry of Finance said today in Tokyo. In addition to the export slump, energy imports rose after an earthquake and tsunami knocked out the Fukushima nuclear power plant, resulting in a 2011 deficit of 2.49 trillion yen ($32 billion).

The numbers highlight a shift toward imports that helped Tadashi Yanai, president of Fast Retailing Co., become Japan's richest man.

Yanai's Yamaguchi, Japan-based company, Asia's biggest clothing retailer, makes all its clothes overseas and imports them for sale in its home market. In an interview in November, he called the stronger yen a “fatal blow” to domestic manufacturing.

“It's like saying, ‘Don't do manufacturing in Japan,” said Yanai, who was listed by Forbes Asia as Japan's richest man in 2010 and 2009, with a net worth of $9.2 billion as of last January.

Japan's currency strengthened to a postwar high of 75.35 against the U.S. dollar on Oct. 31 and traded at 77.98 as of 12:38 p.m. in Tokyo. The currency has gained 5.7 percent against the dollar in the past 12 months.

Eoin Treacy's view For a country which has long depended on a vibrant export sector rather than domestic consumption, the hollowing out of the manufacturing sector is an unwelcome development. However, this is far from a surprise. The strength of the Yen has been a headwind for quite some time. Companies have been warning about the repercussions for even longer, and the Bank of Japan has been half hearted in its efforts to weaken the currency. The challenges arising from the earthquakes and tsunami last year might have been enough to force hard decisions among Japan's corporates. With such a strong domestic currency exporters have little choice but to look at alternative ways of increasing competitiveness. They are embracing the route taken by many other globally oriented companies in availing of cheaper manufacturing outside of their domestic market.

The Bank of Japan appears to have been defending the ¥76 area against the US Dollar since March 2011. It retested the ¥76 area earlier this month and rallied to ¥78 by today. The rate is currently testing the 200-day MA but a sustained move above ¥80 would be required to suggest the Dollar is gaining traction beyond the short-term.

While the Renminbi has strengthened against the US Dollar, it has been largely rangebound against the Yen for a year. The cross rate is currently rallying from the lower side near ¥12 and a sustained move above ¥13 would suggest more than temporary Yen weakness.

The underperformance of the Japanese stock market also reflects the effect of the Yen's persistent strength. Price/Book ratios for Japan have largely tracked the performance of the stock market indices. For example, the Price/Book of the Topix has a similar pattern to the Index and the same is true of the 2nd section and its Price/Book ratio. The value proposition has, so far, not impressed investors probably because the economy is still attempting to recover from last year's natural disasters and the Yen remains too strong. Therefore the above cross rates are worth monitoring for signs of Yen weakness.

The Topix has been ranging mostly in the region of the 2009 lows since August and remains within the confines of a more than three-year base. The Index is currently rallying from the lower side and has returned to test the 200-day MA. A sustained move below 700 would be required to check scope for some additional higher to lateral ranging.

The 2nd Section also remains in a three-year base but has held a progression of incrementally higher reaction lows within it. The Index is currently rallying from the most recent low near 2000 and has broken the yearlong downtrend. While somewhat overbought in the very short term, a sustained move below 2100 would be required to check scope for continued upside.

The Topix Banks Index stabilised near 100 from the middle of last year. It has rallied well over the last couple of weeks and is now testing the upper side of the six-month congestion area. A sustained move above 110 would help bolster the medium-term bullish argument.

In conclusion, we have pointed out since at least 2010 that a weaker Yen was likely required as a catalyst for increased investor appetite for Japanese equities. The stock market has responded to the Yen's weakness since early this month. There have been a number of false dawns in the last two years and the stock market is not expensive by most measures. However, recovery is predicated on a more proactive Bank of Japan and its performance so far has not yet been convincing.

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