by John Vail, Chief Global Strategist, Nikko Asset Management
Given the 4th quarter slowdown in the global economy, it is no surprise that overall corporate profit margins in Japan decelerated during that period.
But before one panics and says that they are about to plummet, one should realise that it would likely require a global recession for such to occur and that the 2005-2007 period showed that profit margins can plateau at a high level for an extended period of time.
Indeed, the four quarter average is still creeping upward to new record levels, and like most of the rest of the world, the manufacturing sector is declining while the non-manufacturing sector is accelerating to record highs. Meanwhile, Japanese profits are performing much better than those in the US or Europe.
We have covered the reasons for such in our recent piece The Japanese Equity Outlook After the Nasty New Year Start, but let us emphasize herein the corporate governance aspect of that piece.
The fact remains that, partially due to the encouragement of the Abe administration, Japanese corporations are continuing their structural shift towards improving profitability.
This is “icing on the cake” of the “Show Me the Money” corporate governance improvement that we have long-highlighted in our thought leadership effort on Japan.
Indeed, while increasing the number of independent directors and other recent governance issues are very important in the intermediate term for Japan, it is crucial for investors to understand that much of the profitability message has actually been understood by Japanese corporates for a decade.
This is shown by the divergence in the profit margins from the trend in GDP growth in the chart below, showing that even though GDP growth has remained subdued, profit margins have surged. Since the Koizumi era, Japan has embarked on major rationalizations in most industries, with the number of players often reduced from seven down to three.