Weak economy and strong yen offer Nikkei no summer respite

IT HAS been a tough 2010 for the Japanese stock market, which is already down some 13 per cent so far this year. Its export-oriented companies have suffered from a toxic mix of a surprisingly strong yen, lacklustre consumption in the West and now depressed domestic demand as well.

Consequently, Japanese GDP growth between April and June was disappointing to say the least – the economy expanded by only 0.1 per cent on the first three months of the year as consumer spending stalled and net exports slowed. This puts the annualised growth rate at just 0.4 per cent, well below the 2.3 per cent that the market was expecting.

As Lindsay Coburn, independent consultant to ING says: “Anything that could come in weaker than expectations did come in weaker in the second quarter GDP release.” Indeed, Japan’s economic output lagged that of China in the second quarter, raising the chance that China will officially become the world’s second largest economy in 2010.

The poor GDP data caused the Nikkei 225 – Japan’s leading stock index – to shed 0.6 per cent yesterday, closing at 9,196.67 and it is in serious danger of falling to the psychologically important 9,000 level, says Manoj Ladwa, senior trader at contracts-for-difference (CFDs) provider ETX Capital.

He adds: “The odds now are for the Nikkei to trade down to the 9,000 level; there are no real key support levels between where we are now and 9,000.” The Nikkei has flirted with the 9,000 level a number of times but it has not traded below it since May 2009.

“If it breaks below 9,000 then it could trade a lot lower because all the stop losses will be taken out and a lot of orders will be triggered,” adds Ladwa.

He reckons that the Nikkei could well go at least a couple of hundred points below 9,000 in the short-term. But, longer-term, if the situation in Japan continues to worsen, then Ladwa reckons that we could see the index sub-8,000 – a level it has not traded at since the dark days of March 2009.

But how likely is it the economic and corporate situation will worsen from here? Further economic deterioration is highly likely. ING’s Coburn doesn’t rule out a downward revision to second quarter growth and says that his initial estimates for the third quarter point to outright contraction in the economy: “The odds that Japan will post two successive quarters of negative growth have clearly increased – we think to around one-third. Japan could be in recession right now.” A struggling economy will further undermine investor confidence and CFD traders could expect to see subsequent weakness in the Nikkei 225.

In terms of the corporate situation, Japanese firms have belatedly woken up to the allure of emerging markets and their burgeoning middle classes. Corporate profitability is up fourfold on a year ago, thanks to a surge in sales to emerging markets. Firms are now rushing to tailor their products to the BRIC countries and the share of exports heading to America and Europe has fallen sharply.

However, any continued strength in the yen poses difficulties for Japanese exporters. A combination of political uncertainty, deflation, and even further quantitative easing should weaken the yen. Ole Hansen, senior manager for CFDs and listed products at Saxo Bank, says: “Corporate Japan is operating on the assumption of dollar-yen above ¥90 for the next six months, so the current level (¥85.47) hurts.” Continued yen strength will clearly hit corporate Japan and, if it persists, its profitability.

The Nikkei is expected to close in on 9,000 in the coming week or so but a sustained fall below this level will require a return to recession and a strong yen. CFD traders should look for an opportunistic short trade but place your stops close.