Market Overview

Japan's Trade Deficit Surges to Record High

Japanese authorities reported a trade deficit for last month that was the biggest January trade deficit on record. A strong yen, after effects from last year's natural disasters and weakening demand in China and Europe were the major contributing factors to Japan's growing trade deficit.

The Japanese Ministry of Finance reported a January trade deficit of 1.48 trillion yen ($19 billion), which was caused by a 9.3 percent fall in exports and a 9.8 percent increase in imports.

Although some Japanese officials have claimed that the country's trade deficits will be temporary, that might not be true if Japan does not get more of its nuclear power plants back online soon. Much of the Japanese trade deficit is being driven by a surge in energy imports that occurred after last year's earthquake and tsunami led to many of Japan's nuclear power plants being taken offline due to accidents and safety concerns.

Although Japan is dependent on nuclear power for much of its energy production, public wariness over nuclear power has increased since last year when the country experienced the worst nuclear disaster since Chernobyl along with a number of nuclear radiation scares. If the Japanese public can't be convinced that its in the country's best interest to increase use of nuclear energy, Japan could remain dependent on outside sources of energy, which would make it difficult for the country to eliminate its trade deficit.

Another factor in Japan's trade deficit is weakening demand in important trade partners like Europe and China. It was announced last week that the euro zone countries economies shrank as a group during the last quarter of 2011. Moody's Investors Service also downgraded a several euro zone countries and warned over 100 euro zone banks that they were in danger of being downgraded. With almost nothing but bad news coming out of Europe, Japan shouldn't expect exports to Europe to increase any time soon.

There have also been signs of weakening demand in China. Until the last several months, Chinese authorities concentrated their efforts on fighting inflation. However, recent economic data indicates a cooling Chinese economy and authorities have for the most part reversed course in order to keep the Chinese economy growing at a brisk pace. If the China is unable to prop up up domestic demand, Japan's trade gap with China could widen. The only bright spot among Japan's trade partners has been the positive economic data that has been coming out of the United States. However, a possible financial collapse in Europe is looming, which could undermine recent positive developments in the American economy.

The strong Japanese yen has also had a negative impact on Japanese exports because it makes it more difficult for Japanese manufacturers to make a profit from overseas trade. Japanese manufacturers like Sony (NYSE: SNE) and Honda (NYSE: HMC) have long complained that an overvalued yen was hurting their bottom lines. Japanese authorities finally acted last week when the Bank of Japan announced an economic stimulus package and set a goal of 1 percent inflation in order to eliminate the deflation that has plagued Japan's economy for most of the last two decades. The yen backed off of its near record exchange rates but if the situation in Europe deteriorates, the yen could start overheating again.

While reconstruction work in Japan is expected to help swing the Japanese economy to growth after last quarter's contraction, the surge of energy imports combined with weakening demand in Europe and China could derail Japanese efforts to give the economy a boost. Investors will have to wait and see if the improving economic outlook in the United States and a weakening yen will be enough to eliminate the Japanese trade deficit.


ACTION ITEMS:

Bullish:
Traders who believe that the Japanese economy will be able recover and go back to generating trade surpluses might want to consider the following trades:
  • The iShares MSCI Japan Index (NYSE: EWJ) ETF and stocks like Sony (SNE), Toyota Motor Corporation (NYSE: TM) and Panasonic Corporation (NYSE: PC) could move higher if Japan is able to swing from deficit to surplus.
Bearish:
Traders who believe that Japan's growing dependence on energy imports will doom the country to a future of deficits may consider alternative positions:
  • Shorting individual Japanese stocks or buying an ETF like the ProShares UltraShort MSCI Japan (NYSE: EWV) could both be profitable investments if Japan's economy continues to decline.
Neither Benzinga nor its staff recommend that you buy, sell, or hold any security. We do not offer investment advice, personalized or otherwise. Benzinga recommends that you conduct your own due diligence and consult a certified financial professional for personalized advice about your financial situation.

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