Japan's GDP result for the second calendar quarter of 2015 showed considerable weakness, but at an -1.6% annualized quarterly rate, it was slightly better than what Bloomberg consensus was expecting and, once again, this kind of negative result does not mean that we should all jump into lifeboats. However, there were several notable points of concern. In particular, personal spending on services was quite weak, as implied by recent monthly tertiary spending reports. Secondly, recent weakness in the monthly reports for unit exports clearly indicated that the quarterly number would be similarly weak. So, with the monthly data in hand, economists were able to predict this last quarter's weakness, but increasing concerns does mean that investors will be scrutinizing the upcoming data even more closely.
As always, there are important things to know about these statistics:
Firstly, these statistics are often heavily revised and it would not be shocking to see the most recent quarter revised up, especially as there were several anomalies in the data. Among these, 1) the CY1Q was revised up fairly sharply, without which, GDP would have only fallen about 0.8% QoQ SAAR. 2) A major anomaly was the "discrepancy factor" (the difference between the sum of the real components and total real GDP) which remains at a very large negative number and likely means that GDP is likely understated. Indeed, one of the major reasons why the CY1Q was revised up was due to an improvement in the discrepancy factor. 3) Real (inflation adjusted) inventories fell less than the prior quarter, and thus, slightly added to GDP growth in the CY2Q, but they continued to decline in yen terms, which means that Japan has reduced real inventories for 22 of the 26 quarters since 2009 began, equating to a 53 trillion yen (about $500 billion using an average 100:USD rate) reduction in accumulated unit inventories since then, while the economy has meanwhile expanded 5%. This clearly indicates understated GDP growth in our view and by comparison, the US has increased real inventories by $752 billion over this period with GDP rising 11% despite utilizing similar technology to improve the efficiency of inventories.
Secondly, GDP statistics have no correlation with corporate profits in Japan. As our Evolving Markets reports have long-shown, despite lackluster GDP, Japanese corporate profits have been quite strong in the last ten years, with the trend clearly continuing in 2015, evidenced by profit margins at historical highs and with recurring profits rising nearly 30% YoY during the quarter. Of course, the weaker yen played some role in this recent trend, but service sector profits were especially strong, which indicates that the economy is not as poor as the statistics suggest. Corporate governance improvements are also obviously a key factor to profit growth in Japan, greatly outweighing the effect of any economic softness and we expect this factor to continue, as it has now become deeply engrained in corporate culture.
As for the outlook, the Bloomberg consensus is for 2.0% QoQ SAAR GDP growth in the next two quarters, so the last quarter was likely an anomaly, but the trajectory of growth has indeed been lowered, so we need to reduce our CY15 estimate to 1.0% from 1.1% (vs. the Bloomberg consensus of 0.9%) which implies 2.9% QoQ SAAR growth in the next two quarters. Within this, we expect 1) real inventories to rise to positive quarterly figures, 2) the discrepancy factor to be sharply reduced, 3) personal consumption to rebound mildly in the 3Q but more strongly in the 4Q and 4) net exports to recover mildly after their sharp 2Q decline.
In sum, as has long been our view, the disappointing economic data should not worry investors in Japanese risk assets very much at all; indeed, TOPIX, driven by strongly rising profits, has risen quite smartly over the past year despite the weak GDP data, thus confounding the macro-sceptics on Japanese equities.