ASIA MARKETS: Japan Machinery-orders Data Fail To Derail Rally

By Lisa Twaronite

Japanese stocks rallied Thursday despite government data suggesting weakness in capital spending, as investors instead showed continued hope that an economic recovery remains on track.

Shortly before the market opened, the Cabinet Office said Japanese core machinery orders, considered a leading indicator of capital outlays, fell 9.3% in July from June, a much deeper drop than the 3.6% average decrease expected by economists surveyed by Nikkei and Dow Jones Newswires.

But the notoriously volatile data set failed to derail the benchmark Nikkei 225 Stock Average's rally. The Nikkei, and the broader Topix index of all issues on the Tokyo Stock Exchange's First Section, both ended up 2.0%.

Banking shares were among gainers, with Mitsubishi UFJ Financial Group Inc.(MTU) up 4.4%, Mizuho Financial Group Inc.(MFG) up 2.0% and Sumitomo Mitsui Financial Group Inc. (SMFJY) up 3.6%.

Those gains were helped by a broad regional rally, with South Korea's Kospi up 2.3%, Australia's S&P/ASX 200 rising 1.1% and Hong Kong's Hang Seng Index ahead by 1.1%.

Some analysts saw glimmers of hope in the details of the machinery-orders report.

"Within general machinery, the drops for internal combustion engines and machine tools were especially pronounced. Within other transport machinery, the most noticeable decreases came in aircraft and railway stock, a reaction to the strength in May and June," said Kyohei Morita, Japan Chief Economist at Barclays Capital in Tokyo.

"Overall, we maintain our view that the manufacturing sector is already finding firm ground with some industries starting to turn up," Morita said in a note.

'Lumpy and naturally volatile'

Richard Jerram, chief economist at Macquarie Securities in Tokyo, said the machinery-orders data were an imperfect indicator of capital spending and its effect on the economy.

"Machinery orders is a series where it is important to understand the underlying dynamics and not become too excited or depressed by a single number," Jerram said in a report Thursday.

He cited last month's 9.7% on-month increase in June orders, which came in about 7 percentage points ahead of expectations, while the 9.3% on-month drop for July in the latest report came in about 6 percentage points below.

"All this really tells us is that the margin for error is wide on this lumpy and naturally volatile series, making it all the more important to cross-reference other leading indicators of capital spending," he said.

Many investors have a problem with the idea that capital spending begins to improve when there is still excess capacity in the system, he said, but this situation "is invariably the case."

The early stages of a recovery cycle "are driven by new technologies or emerging areas of demand, as well as by replacement capex that had perhaps been delayed due to uncertainties," he said. "Rising cash flows and profitability give firms the funds to invest, as well as the expectations of positive returns on the spending."

A separate set of data from the Bank of Japan showed pressure on wholesale prices remains, with the corporate-goods-price index for August dropping 8.5% from a year earlier, slightly more than the 8.4% expected by economists surveyed by Reuters.

The index fell 8.5% on year in July, which was the biggest decline on record.