Japan Economic Comment

How to confirm a cyclical recovery

�� How to confirm a cyclical recovery

Japan’s cyclical recovery can be confirmed in the following order, in our view.
First, the recovery of the industrial production index, which is impacted by
inventory adjustments and export trends, would suggest the start of a recovery.
Next, the Tankan survey’s employment conditions DI, which reflects the corporate
sector’s sense of excess/lack of employment improvement, would suggest the
sustainability of the recovery. Finally, the decline in the jobless rate, a lagging
indicator, would suggest the stability of the recovery.

�� Recovery confirmed (Apr-Jun 2009)

Because of the sharp decline in global trade, financial turmoil, and other reasons,
the industrial production index fell 36.4% from the peak in Sep 2008 to the trough
in Feb 2009. Owing to global monetary/fiscal policy responses and Asian
economic recovery, inventory adjustments progressed quickly, and industrial
production began to recover from Mar 2009. This confirmed that Jan-Mar 2009
was the floor of the economic cycle and that recovery began in Apr-Jun. From the
floor to the peak in Nov 2009, the industrial production index rose by 27.1%.

�� Sustainability confirmed (Jul-Sep and Oct-Dec 2009)

The Tankan survey’s employment conditions DI (+ implies excess employment,
- implies employment shortage) peaked at +23 at Apr-Jun 2009 and recorded +16
in both Jul-Sep and Oct-Dec, improving for two straight quarters. Historically, an
improvement of the employment conditions DI was never accompanied by an
unsustainable cyclical recovery. Following the confirmation of the start of a
recovery in Apr-Jun 2009, sustainability was confirmed in Jul-Sep. Markets began
to factor in a potential double-bottom in H1 2010, due to a reflex response to the
fiscal loosening in 2009, and a negative impact of the strong yen. However, fiscal
policy is expected to be as loose as the previous year in 2010. Further monetary
and fiscal measures and Finance Minister Kan’s comments on preferring a weaker
yen dented the momentum of the rising yen. The added factor of the strong US
market performance confirmed the likely sustainability of the recovery.

�� Stability confirmed (Oct-Dec 2009 and Jan-Mar 2010)

Concerns over liquidity probably have been making companies overly defensive in
terms of financing. Companies have been reducing employment, capex and other
costs in excess of declining demand. Excess corporate savings have been the major
cause of the bloating current account surplus, in our view. Stronger than expected
recovery in exports and production has been the major reason for the strong
recovery in workers’ overtime hours worked. The government’s loan guarantee
and employment programmes for SMEs proved efficient, and there was progress in
employment shifts from manufacturing to services. Despite concerns over reaching
6%, the jobless rate peaked at 5.5% in Jul-Sep 2009 (reaching a high of 5.7% in
Jul), and probably began falling. The jobless rate likely fell in Oct-Dec (Nov:
5.2%), and if this continues in Jan-Mar, this should confirm the stability of the
recovery. The next step would be that the momentum of recovery expands to
wages and domestic demand, thus entering an ‘expansion’ phase. That would
require deflationary concerns to alleviate. We note that our Japan equity research
retail team revised up its investment stance on Japan’s department stores, citing
that the decline in average spending per customer—a factor that has been causing
recent weak department store sales—could come to a halt

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