Japanese earnings

The outlook is especially bleak for non-manufacturers (excluding banks) where profits fell 3.4 per cent, Morgan Stanley (AMEX:MWD) calculates. Banks may have reported smaller subprime exposure than their US peers, but top it up with domestic consumer finance and the dent is sizeable: financials' profits were down 5.6 per cent. Regulatory risk - consumer finance companies' profitability was eroded by new rules lowering the interest rate ceiling - dogs other sectors too. Protracted approval processes for new homes are hurting the construction industry. Toto, for example, which makes bathroom fixtures, has cut its full-year operating profit forecast by 25 per cent.

The second half looks even tougher. The yen has been strengthening and on Wednesday hit Y109/$1, above the level assumed by most companies. Of course, more offshore production and better hedging mean Japan Inc is less sensitive to currency fluctuations than in the past: Goldman Sachs estimates a 10 per cent move in the dollar/yen foreign exchange rate affects pre-tax profit growth by just 2 per cent compared with 5 per cent in the 1990s. Higher oil prices are less damaging than was once the case, but they still erode margins.

Ultimately, the issue for earnings is the same as for the market itself: where is the catalyst for growth? Margin expansion, which marked the first phase of Japan's corporate turnround, was followed by top-line growth. That will be harder to sustain if the US economy slows and domestic consumption remains fragile. The Japanese market is undoubtedly getting cheaper: on companies' own forecasts, it is now trading at 17 times this year's earnings. But that still does not make it an obvious buy.