Toyota's Slowing Sales Lead the Nikkei's Pullback

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Despite the Nikkei index's impressive run over the past month, Japan's leading stock index just hasn't been able to recapture the highs it reached back in May. The Nikkei lost steam this week by falling more than 3.2%, fueled largely by the dollar's weakening against the yen on Friday, an event that took a 3% bite out of the index and made for a poor end to the week for Japan investors.

Even with the big drop, there was a silver lining for Japan. Let's take a look at the latest from across the Pacific-- and check in with what's ahead for investors in the world's third-largest economy.

Inflation bodes well for investors
Even as the yen strengthened, Japan's economy made strong progress in June toward prime minister Shinzo Abe's plans of an economic turnaround. The country's prices jumped 0.4% year over year for the month, according to a report released this week. That's still a far cry from Abe's plans of 2% inflation in the months to come, but it's an important indicator that leading Japanese firms will be able to raise prices in the near future as the economy picks up -- a trend that will translate into financial gains.

As long as the yen can keep weakening against major currencies, particularly the U.S. dollar, the combination of inflation and a bigger boost from international sales will pay dividends to Japan's biggest multinational firms. Investors have already reaped significant rewards with the Nikkei's unmatched run-up this year, but Abe's targets have the index and Japanese stocks poised to continue their run.

The weak yen has covered up for companies that have seen businesses struggle recently, such as Toyota . It's on relative terms that Toyota's struggling -- it's one of the world's leading automakers, after all -- but rival General Motors outsold Toyota for the first time in six quarters in the most recent quarter. That pulled down Toyota's stock by 4.5% over the past week, although the automaker's still performed exceptionally well for investors year to date, with a 33% gain.

Unfortunately for Toyota, this quarter's weakness could be a trend that won't go away. The firm still sold 2.48 million vehicles in the quarter, just .01 less than market leader GM, and ahead of third-place Volkswagen . However, the Japanese market slowed significantly for Toyota, with an 8.4% decrease in sales, and analysts project that to continue, as Japan's population ages and shrinks in the future. Japan's second-leading auto seller domestically, Nissan, has also made up ground on Toyota through a series of price cuts, and has closed the gap between the two companies.

VW and GM also hold a significant lead on Toyota in the booming Chinese market, where political tensions between Asia's two largest economies have soured the public's preference toward Japan's largest car maker. Toyota grew China sales by just 0.6% for the quarter, while VW's China sales jumped 16%, and GM's 12%.

Nonetheless, the weak yen will prop up Toyota's bottom line as long as it keeps selling overseas. Still, it's a moment of weakness at this traditionally sturdy firm that Toyota will need to address in coming quarters.

Toyota's worries were nothing compared to the week's big loser in Japan, Canon , whose stock lost 6.8% this week -- part of an 18.8% decline on the year. The camera maker slashed its full-year sales and profit outlook this week as shipments have fallen, and Morgan Stanley MUFG Securities analyst Masahiro Ono expects worldwide camera shipments to plunge 30% overall this year. Smartphones have gobbled up Canon's market, and forced the company to pare down its profit expectations by 10% in 2013. The weak yen will help Canon reduce the impact of sales declines, particularly as the firm makes up to 80% of its sales outside of Japan. However, the currency's drop will also mean that lost sales will mean much more lost profit overall.

Unfortunately for investors, Canon's a company in a business that's rapidly becoming obsolete. Unless the firm can figure out a way to mitigate the impact of smartphones, don't expect Canon to bounce back in a big way soon.

Canon and Toyota are two companies that will need to make changes in the future -- particularly the latter in the case of China. Toyota's struggled to turn things around in the world's second-largest economy as its rivals surge ahead -- and it'll need to do something fast.

China is already the world's largest auto market -- and it's set to grow even bigger in coming years. A recent Motley Fool report, "2 Automakers to Buy for a Surging Chinese Market," names two global giants poised to reap big gains that could drive big rewards for investors. You can read this report right now for free -- just click here for instant access.

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Fool contributor Dan Carroll has no position in any stocks mentioned. The Motley Fool recommends General Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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