Demographics Start to Work for Japanese Corporate Profits

Some investors are concerned that Japanese companies will have trouble maintaining profit momentum once rationalization efforts run their course. But some such as Daiwa Research say that Japan's rapidly aging population will actually work in favor of corporate profits. Looking at Japan's working population by age group, those that are in their 50s account for some 13% of the workforce, but their wages account for some 17% of total labor costs. Assuming that these workers begin to retire going forward, large companies could see windfall profits of 2%-3% per year, while smaller firms could see windfalls of over 7% per annum to 2011. Moreover, this phenomenon should become much more visible from 2006 onward. The favorable impact will be especially noticeable for the basic materials industries, where the average age of the work force is higher than that of electricals, precisions and automobiles.


Yet while this will mean falling labor costs for corporations, it will have a negative impact on consumption as these retired workers begin dissaving. On the other hand, the younger generation will at the same time begin forming households, and purchasing houses and home furnishings. Japanese think tanks therefore see a very limited impact on consumption expenditures.


(TT's Take) The positive effect on corporate profits from falling personnel costs as the result of increased older worker retirement over the next 10 years will likely be leveraged even further as Japanese companies continue to globalize their operations and are as likely to hire foreign workers for overseas plants instead of replacing the domestic workforce with younger Japanese workers. The implication is that Japan's structural unemployment ratio will begin to approach a level more in line with Western economies. In addition, the newer jobs that are created are likely to carry less "bells and whistles" than domestic industry jobs did during Japan's high growth era, while wages will become much more skewed to "performance". This implies that the divergence in wages and income within Japan's workforce over the next ten years will become much more polarized than it currently is.

Government Abandons End of Deflation Scenario

The CEFP (Council on Economic and Fiscal Policy) had previously forecast rising prices in their medium-term "Reform and Prospects" medium-term economic outlook in FY2005, but in their most recent revision, pushed the time-frame for the GDP deflator to turn positive into 2006 or later, while still allowing that the CPI could turn positive in 2005.


In addition, the forecast is for nominal medium-term GDP growth of 2% to 2006, and for a positive primary fiscal balance by early 2010. The government would like to achieve a JPY1.4 trillion shrinkage in the combined fiscal balance of the central and prefectural governments in FY2004.


(TT's Take) there is more than a dash of wishful thinking in these numbers, and probably includes hikes in taxes such as the VAT tax that have not yet been revealed to the public. The government's total debt as of September 2003 was already JPY655.68 trillion, or JPY11.92 trillion higher than numbers announced in June 2003. About 80% of this debt is in the form of JGBs, the outstanding amount of which is JPY530.169 trillion. With a recovering economy and a mending financial sector, the relative burden of this debt is declining, but not as fast as the new debt is rising.


The Koizumi Administration and Heizo Takenaka is right about fixing the structural problems that hinder the ability of the Japanese economy, corporates and the financial sector to perform, but this huge overhang of debt will continue to place a noticeable drag on economic performance for the foreseeable future.

Individual Investors Again Become Market Players

Stock trading by individual investors, particularly those trading over the internet, is again a factor in the price formation of Japanese stocks. The share of total trading volume by individual investors in 2003 reached 30%, the highest level in 18 years. Internet trading by individual investors now accounts for some 70% of the all the value of stocks traded by individual investors.


But that does not mean that individual investors are buying and holding. Nearly 70% of the companies reporting in September, 2003 (some 854 companies) saw the number of individual shareholders decline compared to levels at the end of March 2003. New tax rules for holding shares are partially responsible, as are recovering stock prices. Individual investors had been setting on holdings of stocks for essentially all of the Heisei malaise, patientlly waiting for a chance to unload their holdings at some sort of gain.


A common theme among listed Japanese companies of late is how to increase their individual shareholders, given the relentless unloading of stock by previous strategic and cross-holders. However, as the aggregate data shows, as soon as stock prices get above break-even levels, both institutions and individuals first take profits on their long-term holdings.


(TT's Take) Individual investors actively trading over the internet have begun to attract a lot of attention, but the amount of stock holdings by these "semi-pro" traders--who in the case of Matsui Securities for example are mainly in their late 50s or older, are a different breed than the bulk of Japan's nominal shareholders who bought or inherited stock decades ago and put them away in their closet. Consequently, individual investors remained net sellers in value terms in 2003.

Repeat of 1996?

As the December Tankan indicated, corporate Japan has become upbeat. Toshiba's (code: 6502) Yokkaichi factory semiconductor factory is running at full ops as demand for digital electronic equipment-related chips could not be satisfied. Fujitsu also reduced their scheduled off days at three factories to pump out the needed chip products. Polypropelene and plastics used in automobile components are seeing 20% YoY growth rates in exports to China, and companies like Mitsubishi Chemical (code: 4010) expect China demand to continue strong until the 2008 Peking Olympics. Moreover, Japanese companies have overcome the downdraft following the bursting of the IT bubble, and are restoring lost competitiveness.


But this increased confidence is also being noticed by Japan's bureaucrats, who would dearly like to raise taxes if they thought they could get away with it. In 2004, changes already made will result in a net JPY10 billion increase in the tax burden, the first in seven years. In 2004, the real tax burden for individual households will include higher pension deductions, lower deductible amounts for dependents and others which will mean an approximate JPY1.2 trillion increase in the tax burden.


(TT's Take) The current recovery in Japan's economy is not attributable to PM Koizumi's "reforms", but to the blood, sweat and tears of individual Japanese companies trying to revitalize their own business models in order to survive in an increasingly global business environment. The recovery in 1996 was just as promising, but was nipped in the bud by premature tax hikes (VAT) by the Hashimoto Administration that were widely attributed as effectively squashing the budding economic recovery.

Japan Rennaisance: Don't Blow It

Kogakuin Professor Yotaro Hatamura has established a non-profit organization named Shippai Gakkai(The Mistake Society), where society members report failures they made and discuss the causes of their mistakes in order to not repeat them. Learning lessons from mistakes is useful not only in science, technology and manufacturing, but could also needs to be applied to the government's economic management.


Japan's economy has finally begun to show signs of life, financial sector risk has abated, and Japanese companies are finally starting to get their arms around restructuring and are producing visible results. What the government needs to do now is to study the serious mishandling of the two prior attempts at recovery in Japan during the Heisei Malaise.


Japan experienced the first attempt at recovery in the economy between 1993~1997. Stock prices rose sharply, and the GDP clocked in at 3% YoY real growth in 1996. However, the recovery was generally considered to have been nipped in the bud by the Ryutaro Hashimoto Cabinet who prematurely decicided to raise the VAT (value-added tax), end special tax cuts, and increase individuals' share of medical expenses in 1997. The result was an additional JPY9 Trillion burden on households, which threw cold water on the recovery.


The second chance came with the economic recovery in 1999~2000, where an IT Boom promised to be the engine that would pull Japan's economy out of its malaise. Stock prices again soared, and again the boomlet was nipped in the bud by crashing world IT markets, and a monetary faux paux by the Bank of Japan. In August 2000, then BOJ governor Masaru Hayami moved to reverse the BOJ's zero interest-rate policy to howls of protest from the LDP and the government, on the mistaken assumption that deflationary pressures were ending.


The BOJ was subsequently forced to reverse policy again as deflation deepened instead of abating. The economy at the time was in fact too weak to cope with the reversal in monetary policy.

(TT's Take) In 2003, Japanese stocks had one of their best years in a long time, and foreign investors, who had all but given up on Japan, began to believe that maybe this time would be different in terms of Japan turning the big corner on its decade-long malaise. But all is not fair skies and smooth sailing. The yen continues its relentless march upward despite massive intervention by the BOJ, while the leading economic indicators and domestic think-tanks like the Japan Economic Research Center suggest that real GDP growth again turned minus in the final months of 2003 as the major domestic demand indicators again turned minus. The economy is still very dependent on foreign demand, while domestic demand is being hampered by encroaching rises in health care and other costs, and continued high unemployment.


The country's fiscal crisis is worsening mainly because of a decline in tax revenues resulting from Tax revenues are projected to decline by about 9 trillion yen in the three years through the end of fiscal 2003. The government is again talking about significant hikes in the VAT, albeit a few years down the road. The rate of decline in the consumer price index, began shrinking in spring last year, but there is still lingering deflation. The moratorium on the full removal of bank deposit guarantees expires in April of 2005, while there is still much clean-up work to be done among the smaller regional banks.


The BOJ has no choice but to continue their intravaneous "super-loose" monetary policy injections into the economy, and to do whatever they can to impeded the upward pressure on the yen. The Koizumi Administration should where ever they can resist the temptation of the government and bureaucrats to effectively raise taxes and kill the goose that is finally trying to lay a golden egg.


Finally, the government has again planning to flood the market with script as the divest themselves of further holdings of NTT and Japan Tobacco in 2004. As such issues have historically closely coincided with interim peaks in the stock market, investors cannot afford to ignore the negative implications of the combination of large new issues and a slowing economy in 2004. Yes, Japan's economy and stock market are again attempting to break out of the Heisei Malaise, but it will require cool heads and steady hands at the BOJ and current Administration to ensure that past policy mistakes that could derail this budding Rennaisance are not repeated.


Yomiuri Editorial

Corporate Japan Regains Cash Flow and Vitality

Corporate survivability -- aas measured by subtracting profits that are necessary to pay dividends, executive compensations, interest payments, taxes and others essential for sound corporate activities from business-generated profits, came to 1.6 billion yen per company on average in fiscal 2002, according to a survey by The Nikkei Business Daily. Business-generated profits are the sum of operating profits, interest income and dividend income. The survey covered 852 nonfinancial companies listed on the first section of the Tokyo Stock Exchange whose consolidated financial data over the past 10 years is available. Of the 852 companies surveyed, 349 had a positive earnings figure as a measure of their survivability.


This measure of survivability had been in negative territory for 10 straight years since fiscal 1992. Behind the recovery in survivability is an improvement in business-generated profits. Business-generated profits before interest and other expenses at the companies surveyed averaged 22.4 billion yen in fiscal 2002, the highest level next to the 23 billion yen for fiscal 2000, which was characterized by the information technology boom. At the same time, profits that are necessary to pay expenses essential for corporate activities kept declining, sinking to a record 20.8 billion yen on average, compared with 32.8 billion yen for fiscal 1992. Underlining their efforts to streamline their finances, these companies saw interest and bill discounts paid drop to 3.4 billion yen on average from 11.3 billion yen for fiscal 1992. At the same time, dividend payments shrank to 2.8 billion yen from 3.5 billion yen per company on average.


(TT's Take) When it came to the survivability of individual companies, Nippon Telegraph and Telephone Corp. (9432) ranked first, followed by Toyota Motor Corp. (7203), Nissan Motor Co. (7201) and Honda Motor Co. (7267). Conversely, electrical machinery makers in general had poor survivability. Their average earnings figure as a measure of their survivability at 123 firms was a negative 8.3 billion yen, staying in minus territory for the eleventh straight year. In particular, Sony Corp. (6758) has the lowest survivability, followed by Matsushita Electric Industrial Co. (6752) and Hitachi Ltd. (6501). Sony's businesss-generated profits before interest were 199.8 billion yen, but profits that are necessary to pay expenses came to more than double the amount for the company, totaling 457 billion yen.

(from the Nikkei, January 1, 2004)

2004 Consensus: 13,000 on Nikkei 225 by Mid-Year

55 fund managers and market strategists surveyed by The Nikkei Financial Daily forecast that the Nikkei Stock Average will peak at around 13,000 in the middle of the year. the survey showed mixed opinions about the second half due to a plethora of uncertain factors such as the outlook for the U.S. presidential election and speculation about rate hikes in numerous countries. With the market likely to harbor increased concern about the outlook, most believed share prices could peak out in the summer.


(TT's Take) Also in the consensus is; a) a continued weakening in the US dollar, b) a move by the FED to become more restrictive on monetary policy, ostensibly in the second half of the year, c) limited downside risk in Japan's equity market.


The consensus stock picks for 2004 include:

Takeda (code: 4501, CHART)


Toyota (code:7203, CHART)


Matsushita (code:6752, CHART)


Nippon Steel (code:5401, CHART)


JFE (code:5411, CHART)


Mitsubishi Corp. (code:8058,CHART)


Shosen Mitsui (code:9104, CHART)


Shin-Etsu Chemical (code:4063, CHART)


THK (code:6481, CHART)


Sharp (code:6753, CHART)


Ricoh (code:7752,CHART)


Mitsubishi Tokyo Financial Group (code:8306,CHART)


TT however must note that the historical performance of consensus "picks" has not been good, as whatever good news and market respect the market has for the stock is usually already discounted--i.e., they are usually already priced to reflect the consensus bullish view.