Growing trade deficit pressurizes the Japanese yen
The below graph reflect the source of Japan’s trade deficit—China. The prior graph reflected Japan’s large trade deficit due to oil. Japan continues to grow its trade deficit with China, while Japan’s pre-2008 crisis trade surplus with the European Union has essentially disappeared. Japan’s trade surplus with the U.S. has simply declined to half of what it was in 2007. This article considers the impact of Japan’s trade dynamics on the Japanese automakers.
The yen should weaken
The above graph suggests that Japan’s ongoing trade deficit will put pressure on the Japanese yen. As the yen weakens against the U.S. dollar and the euro, Japanese domestic automakers will benefit from the decline in their production base costs. This trend should support Japan’s autoworkers in the future, as they may gain increased pricing power against their U.S. competitors, such as GM or Ford. Overall, these trends paint a positive outlook for the Japanese export growth in the long run; although in the short run, the immediate rise in the cost of imports will likely have a chilling impact on growth and consumption. In the near term, investors may shy away from exporters on the back of weak domestic economic data. However, in the long term, export growth should provide the foundation for improved corporate profitability, which is already excellent by historical standards.
Read about Japan’s shocking February trade deficit data in the next part of the series.
For an overview of the April 1, Bank of Japan Beige Book on Japan’s economic outlook, read Bank of Japan Tankan supports a 2014 equity rally in Japan.
Japan’s equity outlook
As 2014 progresses, investors could see a continued outperformance of Wisdom Tree Japan Hedged (DXJ) and the iShares MSCI Japan ETF (EWJ) versus China’s iShares FTSE China 25 Index Fund (FXI) and Korea’s iShares MSCI South Korea Capped Index Fund (EWY). Plus, as Japan pursues unprecedented monetary expansion, and the U.S. Fed tapers its bond purchases, Japanese equities could also outperform the broad U.S. equity indices, as reflected in the State Street Global Advisors S&P 500 SPDR (SPY), State Street Global Advisors Dow Jones Index SPDR (DIA), and Blackrock iShares S&P 500 Index (IVV).