Why Japanese corporates are less reliant on dollar-yen rate for profits

US-based Tesla fans are never short of excuses for smugness, but they were handed a peach this week with the latest edition of the Cars.com American-Made index.

The study, which ranks vehicles’ American-ness on criteria such as assembly location, component origins and manufacturing workforce, placed all four Tesla models in the top 20, with the Model Y and Model 3 in the top two slots. Drowned by the whooping of Teslaholics, though, was Honda’s altogether cheekier colonisation (once you include the Acura brand) of an unbeatable seven of the top 20 places.

For close followers of Honda’s long-term offshoring strategy — and those of other large Japanese manufacturers — this came as little surprise. But it provides a timely reminder, perhaps, of why the current historic cheapness of the yen — now bobbing around a 24-year low — is not producing the effects that many investors might have come to expect.

Historically, there was a good reason why traders in Tokyo nicknamed the dollar-yen exchange rate “the paymaster”: the profitability and competitiveness of large parts of corporate Japan once had a high sensitivity to its level, and the performance of equity markets had a high correlation with its swings.

Certain aspects of the paymaster’s influence have shifted over time, but its overall capacity to set the tone around the Japanese stock market has never felt like something that would vanish overnight. For most of the period since the 2008 global financial crisis, extended spasms of yen weakness have pretty consistently juiced stocks higher, on the logic that this is good for exports, and exports are where Japanese corporate profits are made.

But that link, says Shrikant Kale, a quantitative analyst at Jefferies, is looking decisively broken and the sensitivity of the Japanese market to the yen has fallen sharply. During the period between 2012 and 2015, when the yen sank most dramatically, the MSCI Japan index had a consistently high correlation of about 0.7 with the dollar-yen rate.

The direct translation of yen weakness to widespread earnings upgrades was, in reality, patchy, but the overall narrative (around Abenomics reforms and stimulus) drove stocks higher: the yen fell almost 60 per cent over that period, and the MSCI Japan rose 128 per cent.

But the correlation began to slip in 2019 and has since plunged more severely. It now stands, says Kale, at just 0.14. Sectors such as autos, insurance, tech hardware and consumer durables, which were clear beneficiaries of yen weakness in that earlier phase of yen devaluation, are emphatically not benefiting this time around.

Other analysts have reached the same conclusion through different routes. For example, when the brokerage CLSA looked at the share prices of companies that had declared the highest positive impact on operating profits of a downward move in the yen, they showed almost no correlation with the currency over the past three months, during which time the yen fell almost 10 per cent.

The cause of this breakdown, many analysts argue, is illustrated by the deep Americanness of the cars Honda sells in the US. The ratio of Japanese manufacturers’ overseas production ratios have been rising for three decades, and have now plateaued at 22.4 per cent, desensitising those companies to big moves in dollar-yen.

Government surveys suggest that, for automakers and their supply chains, that ratio is due another phase of increase. These offshoring decisions are not being made, as they might have been in the past, to chase lower labour costs, but because ever larger parts of corporate Japan are deciding to build their products closer to their customers. That is structural and, in all probability, irreversible. As is the dwindling influence of the paymaster.