(Kyoto)-September’s anti-Japanese protests in China over the disputed Senkaku/Daioyu Islands may have come and gone in the Western press, but the real damage is only just beginning for investors who have piled into Japan in recent years.With their focus on the U.S. fiscal cliff and ongoing EU banking problems, many investors just don’t understand how interlinked trade between China and Japan has become, nor the breadth of the damage this strained relationship can do to their portfolios.But they’re about to.
The breaking news here in Japan is that Honda (NYSE:HMC) cut its full-year net profit forecast by 20% following a 40% drop in September sales. That marked a 16-month low in sales that is directly related to nationalistic friction between the two nations.That’s adds up to a 95 billion Yen hit. To put this into perspective, Honda’s net profit last year was only 211.4 billion Yen, so we’re talking about a nearly 50% drop in the company’s bottom line.
Under the circumstances, I would be very surprised if Nissan (PINK:NSANY) and Toyota (NYSE:TM), both of which also have significant operations in China, don’t follow with similar results when they report next week. While I haven’t seen estimates from Nissan yet, Forbesreports that Toyota sales are off a staggering 49% over the same time frame.
That’s the biggest drop in a decade.That’s not inconsequential considering that Chinese-Japanese trade accounted for more than $340 billion USD in 2011. Japan is China’s fourth-largest trading partner after the EU, the U.S. and the ASEAN nations respectively. It accounts for approximately 10% of China’s total annual gross trade volume according to Xinhua.
On the other hand, China is Japan’s largest trading partner and has been since 2007 when Japanese corporations dropped the U.S. market like a hot potato. China is also Japan’s single largest export destination, accounting for nearly 25% of total export volume as well as the single-biggest source of its imported goods.
The damage won’t be limited.
Big Trouble For a Wide Range of Players
I expect Japanese airlines and Chinese airlines to hit turbulence, too.
Since the widespread violence in China this fall, legions of tourists and business travelers alike continue to cancel trips. While Japanese travel agencies report a drop in bookings to China, Chinese agencies are getting out of the game altogether and it’s not just the bit players, either.
Xinhua reports that China International Travel Service Limited, China Comfort Travel and China CYTS Tours Holding Co., Ltd., have stopped selling travel to Japan entirely.
Reports here suggest that Nippon Airways (PINK:ALNPY) and Japan Airlines (PINK:JALFQ) cancelled upwards of 20,000 seats on routes into China in late September and early October. It is not clear if — or when– they will be added back into flight operations.
At the same time, Chinese airlines, including Air China, China Southern and China Hainan Airlines, have also cancelled flights and cut seats to Japan while also postponing valuable new routes to both Sendai and Okinawa.
Anecdotally, my friends tell me that many formerly full flights between the two countries are half full at best.
Japanese home appliance makers are not immune, either.
Executives I spoke with this weekend, who wish to remain anonymous because they are not authorized to speak on behalf of their companies, suggest that monthly sales in Chinese retail outlets could be off 45%-70% by the time the damage is “done.”
I pressed for clarification as to when that might be and didn’t get any officially. But their cold silence spoke volumes about what they expect through year end.
For Every Loser, There is a Winner
So what do you do about this? That depends on four things.
First, the situation is unlikely to go away any time soon. In fact, I believe it’s going to play out well into the fourth quarter. Any Japanese company doing business with China is at risk.
Many are names you know, but if you have invested in Japanese ETFs like many investors have, there are a lot you don’t know, too. This is particularly true if you factor in the extensive supplier network of second- and third-tier Japanese companies behind such well-known names as Mitsubishi, Honda and Toyota.
Second, China plays the nationalist card at its discretion and tacitly fans the flames whenever it is convenient. Its citizens, many of whom have yet to grasp the subtleties of international politics because their view of the outside world is extremely limited, react predictably when they perceive they have been wronged. So the situation and its impact on earnings is unpredictable at best.
Third, there is the very real and growing possibility that China will use military force to take the Daioyu Islands back. Since 1949, China has been involved in 23 territorial disputes and has used force in six of them – all of which resemble the Senkaku/Daioyu dispute, according to M. Taylor Fravel, an associate professor of political science at MIT and the author of Strong Borders, Secure Nation: Cooperation and Conflict in China’s Territorial Dispute (Princeton, 2008).