Japanese Banks Willing to Lend, But Corporates Awash in Cash…

The two most interesting outcomes from the latest Tankan survey were weak corporate inflation expectations and the highest willingness to lend by banks since 1997. Corporate executives overall see consumer prices rising 1.5% over the next year and barely half the BOJ’s objective at 1.1% for large companies ex the sales tax rise impact. Inflation expectations are lagging BOJ rhetoric and while this survey is a new attempt to capture inflation expectations within the traditional survey, it certainly doesn’t suggest an imminent wage and capex surge. Retained earnings by Japanese companies rose to a record high of 293trn yen in Q4, and those retained earnings have of course been a key support for the JGB market as household savings fell over the past decade. While the proportion of mid-sized companies saying banks are willing to lend rose to the highest level since June 1997, corporate demand for credit remains very limited, aside from pockets of foreign M&A. Indeed, outstanding lending to companies increased by 2.2% y/y in February, but the total outstanding amount of 275trn yen remains below levels in 2009. If inflation expectations weaken further in the next Tankan survey, the BOJ will be well behind the curve and perceived to have repeated its late 1990s error.

In fact, there is a strong case that Japanese companies are overinvesting (at the expense of shareholder distributions), partly for tax reasons. In the US, listed company corporate capex has pretty much matched combined buybacks and dividends in recent years (at $770bn last year) but in Japan capex is running at over 5x dividends plus buybacks, a ratio that has been trending up since 2009. Business investment amounts of 13% of GDP, compared with (a historically low) 10% in the US – the key structural issues are the lack of reform to the gerontocracy running Japan’s leading companies (director term limits, mandatory retirement ages etc.) nor any measures to make activist investing easier, a key factor in forcing US tech companies to distribute their cash hoards.

While the earnings revision ratio has turned negative for most global sectors and markets as detailed previously, Japanese financials have been an exception and yet banks tumbled almost 20% in Q1 – alongside real estate (and the next BOJ buying round will focus on ETFs and J-REITs) there is scope for outperformance in Q2. Loan volume began picking up in late 2012 and y/y credit expansion is now running at just under 3%, and set to grow at 3% – 3.5% in the next two years. Rising mortgage and consumer-loan volume has been a key positive, while demand for corporate loans has been flat to negative. Japanese non-financial corporations had $1.56trn of cash on their balance sheets at end Q4, up 6.4% y/y and half of listed companies are net cash-positive. Meantime, Q1 was a reminder that Japan still trades like an emerging market with foreign investors accounting for 60% of volumes, but relative earnings momentum and valuations support while extreme long positioning back in January has largely reversed.

Japan’s Consumer Confidence Index has been trending down since last May, falling in February to the lowest reading since September 2011. The Tankan survey showed expectations in the retail sector particularly bearish, worrying when the recovery since 2012 has been driven by domestic demand rather that exports. CPI has reached 1.3% y/y but the energy component was large in February, gaining 5.8% y/y and adding half a percentage point to the overall increase. Housing starts are down 12.9% over the two months through February, industrial production, which rose 10.3% y/y through January (partly on expectations that consumer spending might surge before the tax hike) dropped 2.3% m/m in February. In fact, the pre-tax rise consumption boost has proved to be very underwhelming – Japanese household spending fell 2.5% y/y in February. While that may imply a less severe post-tax hike contraction, the BOJ will be lobotomized by the LDP if it squanders the momentum of Abenomics (which depends critically on asset inflation for its wider economic impact). There is enough evidence of deteriorating momentum to see belated BOJ intervention by the end of this quarter, and after their sharp YTD selloff, financials/REITs would lead any consequent rally…