Since the start of Abenomics, Japanese corporate profitability has surged on the back of easy monetary policies and a weaker yen. Further gains in profits have been anticipated on the heels of pro-business structural reforms that are part of Abe’s economic growth strategies, which include a cut in corporate tax rates.
Because of the strong gains in profits, Japan remains one of the lowest-priced regional markets on a price-to-earnings basis and was the only major regional developed market that had earnings outpace price gains since Abe was elected.1 I wrote here why I believe the drop in Japan’s stock prices in 2014 offers an attractive entry point.
One set of concerns for Japan regards the implementation of a consumption tax hike from 5% to 8% and the expected fallout for Japan’s local economy. Yes, a tax hike is typically short-term negative for local consumption and negative in regards to economic growth. But a key question is whether any drag on economic growth will translate into weaker profit growth from Japan in the aggregate.
And here the data is quite illustrative: overall corporate profits for Japan have historically shown no relationship to the growth in the Japanese economy.
Profits Not Correlated with Gross Domestic Product (GDP)
Our friend Nicholas Smith, Japan Strategist at CLSA, recently published a research report summarizing the effects of Abenomics thus far and providing CLSA’s outlook for Japan’s future.2 In the report, he highlighted an important relationship between GDP and corporate profits:
Since the end of 1997, Japanese nominal GDP dropped 8% while corporate profits rose 108%. The correlation between GDP and profits was 1%, which is geek-speak for saying that the two moved in opposite directions quite as often as they moved together. Corporate profits are absolutely not a simple derivative of GDP growth. As long as global conditions are improving, companies should be able to deliver fair growth.”
Figure 1 helps illustrate these findings.
Figure 1: Japan GDP vs. Corporate Profits