Japan tech stocks line up to downgrade earnings.

The performance of Japanese tech stocks has been even worse, despite a digital consumer electronics boom that helped to support stock prices in 2004. Basically, the pendulum in equipment purchased in late 2003 and 2004 swung too far; as semiconductor manufacturers didn't need a 50 pecent plus increase in equipment purchases for only 27 percent growth in semiconductor sales. We see the poor performance of tech continuing at least through 2005, despite the occasional relief rally.

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In January NEC downgraded their FY3/2005 forecast by C15 billion to a 26% YoY decline. This is the second earnings downgrade. One major reason is poor earnings at NEC Electronics. Kyocera now expects consolidated operating profit for FY3/2005 to decline by 13 percent to [yen]95 billion, short of the initial projection by [yen]40 billion. The downgrade was attributed to sluggish demand for electronic parts and poor performance of equipment-related operations, which include cellular phones and digital cameras, because of a sharp drop in prices. Canon Sales is now expecting operating profits to decline 15 percent because of weak semiconductor equipment. Arisawa Seisaku also downgraded their FY3/2005 earnings by [yen]7.8 billion because of weak demand for mobile phone and digital-electronic-equipment-related sales of flexible printed circuit boards. These announcements came as Sony was reporting a 13 percent decline in operating profit for the October-December quarter of 2004, especially on weak electronic equipment sales. Hitachi Software Engineering now expects it will have a group net loss of [yen]7.3 billion yen in FY3/2005, rather than its previous projection of [yen]3.6 billion profit.

Elpida Memory said consolidated net profit for FY3/2005 is now projected at [yen]12-16 billion, short of its initial forecast by almost [yen]10 billion. The major chipmaker attributed the downgrade to weaker-than-expected DRAM shipments because of inventory adjustments at digital home electronics makers and falling prices. Finally, Fujitsu downgraded its FY3/05 operating earnings by [yen]30 billion due to weaker-than-expected software services and larger-than-expected price declines in plasma display panels.

The problem is not only Japan-centric. The world's largest contract-manufacturer of microchips, TSMC of Taiwan, has posted its first quarter-on-quarter drop in profits in almost two years as a supply glut hit orders. According to Chairman Morris Chang, "We expect most of [the inventory] reduction to be done in the first quarter of 2005." But as the silicon cycle will continue downward in 2005, it is unlikely a major tech earnings recovery will occur in 2005. Moreover, Japan no longer dominates the world's consumer electronics markets. Contrast the earnings downgrades in Japan with Samsung Electronics of South Korea. The company reached a milestone this past business year by netting profits in excess of 10 trillion won ($9.6 billion). The actual reported figure was close to 10.8 trillion won, and an 81 percent increase over the 2003 business year. There were only nine companies in the entire world that posted net profits of more than $10 billion in 2003, and Toyota Motor Corp. was the only manufacturer in that group.

Commodity Stocks Rebound

Last winter, ships had to wait up to a month to discharge iron ore and other bulk cargos at overcrowded Chinese ports, power failures were widespread because of inadequate generating capacity and food prices leaped as demand grew faster than farmers could increase production. But port delays, power disruptions and food price increases have, reportedly, diminished, though they have not disappeared. Companies have also learned to work around problems like blackouts. The Chinese government managed to expand the capacity of many ports 30 percent to 60 percent within months, a task that would take years in practically any other country. Chinese iron ore statistics, released following Beijing's revelation of sizzling December quarter gross domestic product growth of 9.5 percent, show another facet of the fast-changing balance between Asia's two most important economies. Despite a government clampdown on new steel-making, aluminum and cement production, China last year became the world's biggest iron ore market, owing to a 40 percent increase in imports to 209 million tons. Commodity stocks such as Rio Tinto Group and JFE Holdings rose after the bullish China report. Surging demand form China helped drive a 23 percent increase in the price of zinc and a 37 percent jump in copper prices last year, not to mention US$55/barrel for oil. Thus, despite all the concern about slowing Chinese and world economies, expectations that oil prices would peak and decline, and of a general bursting of the commodity market bubble, the CRB futures index is nearing the completion of its second consolidation since April 2004. The April correction was around 7 percent following a 26 percent rally from April 2003, while the latest correction has been much more shallow. According to the United Nations, the global economy is expected to grow at a rate of 3.25 percent in 2005, following an increase of 4 percent in 2004. That is not exactly a major slowdown, either. The United States and China continue to be the principal engines for the global economy at present. The GDP of the United States is estimated to have grown by at least 4 percent in 2004 and is expected to grow by 3 percent in 2005. Growth in China reached 9.2 percent in 2004, and is forecast to fall to 8.75 percent in 2005 as China has taken actions to bring the economic expansion to a more sustainable rate.

CRB Futures Index

The Japanese stock market is not immune to debate about the US market, particularly as regards the bull-bear debate. Consequently, Japanese shares have been hobbled by the successive downgrades in tech stocks. The Japanese market is again pushing its 200-day moving average on the downside, which is currently around 11,000. The Nikkei 225 has basically been trending within a channel of 11,500 to 10,500 since July of last year. But if downside risk at 11,000 can be confirmed, the market is poised to test previous highs sometime in 2005.

Darrel Whitten has been analyzing and writing about Japan's financial markets for over 25 years. A former head of equity research at the Japanese operations of three global investment banks, he is owner and Managing Director of Investor Networks, Inc., a Tokyo-based investor relations consultancy, and is also the editor and publisher of The Japan Inestor.com website, a subscription site for serious investors in Japan.