Schroders: Japanese corporate earnings

In the background, however, company profits have been growing steadily and there have been consistent upward revisions in profit expectations despite a summer of weak economic data. Corporate behaviour, as observed through hiring plans and capital expenditure plans, also suggests growing confidence in the business environment going forward.

Adding to this sense of dislocation, this strong profit performance has been occurring during a period of unusually sluggish export growth, which we would normally expect to be a key part of Japan’s economic growth. Instead, companies seem to be reaping the benefits of their previous strategy to locate production assets offshore. This is allowing companies that were previously dependent on the exchange rate to benefit, even while export growth remains anaemic.

Meanwhile, domestically, it seems that the easy monetary conditions created by the Bank of Japan have enabled even relatively low growth to be translated into strong profit growth. Essentially, we are now seeing the benefits of restructuring and cost cutting, which were undertaken during the country’s period of deflation resulting in higher operational gearing for companies. Those companies with pricing power are now seeing the early benefits of Japan’s exit from deflation as this allows revenue to grow faster than costs.

While macro economists are waiting for evidence that higher inflation expectations will lead to wage growth, companies are taking advantage of the current environment and corporate profits as a share of GDP is increasing. However, this shift has come at the expense of labour.

Going forward, it seems inevitable that this situation must normalise as incomes grow over the next few years. Therefore, investors need to be slightly cautious of companies who have benefitted in recent years only through switching to part-time labour as many struggle to retain the staff they need. Nevertheless, even with a tighter labour market and rising wages, for listed companies in aggregate, conditions are likely to remain good for continued profit growth.