U.S.-Japan Trade Deal Could Trigger A Rally

As the end of the long Japanese Golden Week holidays approaches, several positive triggers for Japanese equities are coming into sight. On the domestic front, the key standout is the full fiscal year 2018 corporate results season over the coming three weeks, which, in our view, is likely to mark the end of the earnings revisions down cycle that started last October. On the international front, the full state visit by President Trump to Japan scheduled for May 25–28 is very likely to bring the successful resolution of a U.S.-Japan bilateral trade agreement. If we get similar positive news from the U.S.-China trade front, Japan in general and exporters, in particular, could outperform.

Of course, the two pieces—earnings revisions and trade—are highly codependent, with trade and global demand still by far the most dominant force driving corporate profits. Specifically, approximately 64% of TOPIX earnings come from global demand, either through exports or offshore production. Domestic Japan accounts for barely 36%. By region, the U.S. is most important, accounting for approximately 25% of all TOPIX profits. China’s importance has grown to approximately 15% and non-China Asia for about 12%. Make no mistake, the U.S. and China combined account for as much of Japanese corporate profitability as the domestic market, and when you add the feedback loops between China and non-China Asia, it was inevitable for Japanese earnings to be hit hard by the China slowdown. Fears of trade wars and tariffs clearly compounded the downshift as corporate leaders canceled or postponed business investment and capacity expansion plans.

For Japanese earnings, the numbers speak for themselves: in July 2018, consensus expectations were for a 12% rise in corporate profits for 2019. Now, expectations are for basically zero growth and, in our view, when the results will come in over the next three weeks, it is likely that reported profits may have declined by as much as 5% for the full-fiscal year 2018 (which ended March 31, 2019).

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