Japanese earnings momentum grew in Q2, as positive surprises outpaced by negative surprises by 62 percent, and there appears to be room for even more growth in Q3 according to Citi’s Japan Equity Strategist Kenji Abe.

The positive surprise ratio for Q2 was 62 percent, up from 55.6 percent in the first quarter of the year, and the percentage of companies that had both falling revenues and earnings fell from 25.5 percent to 18.3 percent. The number of companies that reported falling revenues and rising earnings fell to 11.2 percent in Q2. Usually companies in this group are focusing on greater efficiency and other cost cutting measures. Assuming the Japanese recovery continues these companies will be well positioned to show growth in both revenues and earnings, and could contribute further to earnings momentum in Q3.

Earnings seem to be strong investor pull right now

Share prices fell in Q1, despite the good news overall, but “we note that names that generated a positive surprise turned in relatively good performance, and we discern a tendency for the performance gap to be larger seven days after results than one day after,” says Abe. “This suggests investors are increasingly basing stock selection on earnings.”

Earnings japan pos surprise ratio

While the surge is welcome news, it is more dependent on the Chinese economy than Japanese business leaders care to admit.

Japan’s economic bounces deflated by Asian crises

“A one-percentage-point decline in China’s gross-domestic-product growth rate slows Japanese growth by half a percentage point,” according to Mayumi Negishi and Daisuke Wakabayashi at The Wall Street Journal. China is Japan’s biggest trade partner, accounting for 20 percent of Japan’s overseas sales, but the days of explosive, double digit growth are over. Manufacturing for internal consumption is also growing in China, provide competition for Japanese products that are easy targets for anti-Japanese sentiment.

Negishi points out that Japan has already seen a number of potential rebounds come up short in the face of the 1997 Asian currency crisis, the dot-com bubble in 2000, the 2008 financial crisis, and the 2011 earthquake and tsunami that battered Japan. If a hard landing in China does bring a quick end to the nascent Japanese recovery it would be another in a long line of external hurdles that Japan had not quite cleared.