Japan squares up to economic aftershocks

Frank Packard

Japan Representative, Triple A Partners

When the Big Quake struck on Friday afternoon, March 11, I was in the office in Tokyo. After 30 seconds of wild gyrating we knew it was going to be a big one. After another minute of non-stop shaking and grinding, my office mates and I fled down the stairs and on to the streets. Nearly every office nearby had emptied in a similar fashion, and so the streets and the park across the street all became quite crowded.

We waited for 20 minutes, returned to the office, and then about 20 minutes later an aftershock that seemed as large and as long as the first one hit us. We repeated the cycle once more: flee, wait in the park, and go back to the office. Within less than hour a third quake came. Most of the office staff and I decided to leave for the day.

The next morning all these services returned to normal operation, yet the earthquakes continued for the next three days, and now we feel grateful that we “only” have two or three a day. However grateful we may feel for less frequent quakes from nature, the effects of man-made decisions are going to be deep and long-lasting. The electric grid is a sad representation of the factionalism and regionalism that can sometimes appear in this country. Japan, one of the richest countries on earth, never established a unified national electric power grid. I cannot think of any other modern country that has allowed such a situation to arise.

The panic of fleeing foreigners has been a bit overdone, and often the reporting of the media has been cartoonish. Fox News identified “Shibuya Eggman” as a central Tokyo nuclear power plant that happens to be at risk of having a meltdown. This venue happens to be a reasonably well-known concert hall.

Moving from the personal to the larger business picture, in the near-term Japan has definitely been knocked by the disasters that happened this month, but the country has not been rolled over. If anything, Japan is showing some of its best attributes of perseverance and inner strength. Many people overseas are concerned about how these events will influence the behavior of investors in Japan. A common misconception is that there is only one ‘Japan’. I believe there are many ‘Japans’ and some parts will do better than others.

There have been concerns about Japanese investors bringing back overseas funds in order to deploy them in the reconstruction efforts. Perhaps that contributed to the rise in the yen versus the dollar immediately after the earthquake. No doubt we shall see some extreme fluctuations in the value of the yen in the next few weeks.

Every international and local financial firm seems to be operating normally. Some firms, such as OGI Capital Partners, an asset management firm, have such robust business continuity plans that they were able to move one of its fund management teams over the first weekend to a back-up site in Osaka, from where they have been operating smoothly.

The financial markets in Japan give every indication of being fully operational with lots of local liquidity. There has been a wide dispersion of stock market moves, from large gains in share prices in the construction industry, to large drops in Tokyo Electric and nuclear power-related companies.

In terms of asset management and concerns about redemptions from funds, most hedge funds permit dealing no more frequently than on monthly notice. I would be surprised to see hasty redemptions as long as managers continue to do what they said they would do, namely, offer transparent reporting, normal liquidity, and adherence to the mandated investment strategies.

Toru Ibayashi

Head UBS Wealth Management Research, Japan

It will likely take years to calculate the immense damage caused by the quake (the most severe in Japan’s history) and the devastating tsunami that struck only an hour later.

In addition to the human toll of these tragic events, analysts are now pondering the effect the crisis will have on Japan’s overall economic growth and the prospects for a previously expected recovery. They are also scrambling to assess the gut-wrenching volatility seen in the stock market. Although the situation remains in flux, especially regarding the difficulties in Fukushima, we do not believe the crisis will lead to further downside for the Japanese economy.

Moreover, although the stockmarket looks certain to remain hampered by this crisis for some time, we believe there are companies that have seen their share prices unduly beaten down in recent days (especially those with an focus on international markets), and we advise considering the relatively strong prospects for these companies over the rest of this year.

For the last two decades, Japan has been suffering from deflationary pressure caused by excess production capacity and weak demand. However, we believe these events will finally adjust Japan’s supply-demand balance. The reconstruction of the afflicted area is expected to begin in earnest during the second half of this year, and this should help lift the Japanese economy from its deflationary cycle in the medium term.

The equity market situation is just as challenging. However, as with the overall economy, there are reasons to believe optimism can still exist among such tragic circumstances. The shares international investors tend to own are often issued by companies with significant international business exposure. In other words, they tend to include Japan’s best companies, many of which are expanding their sales in emerging markets.

Given that we expect these companies’ business operations in Asia and other emerging markets will not be affected by the quake in the long run, we believe investors should view the slide in Japan’s equity market as an opportunity to invest in the nation’s leading companies.

Steve Seneque

Head of Japanese Equities, Fidelity International

We saw extreme volatility in the market following the earthquake and tsunami that hit the northern part of Japan’s main island and selling was indiscriminate.

As a result of the correction, the price to earnings multiple for the Topix based on the Toyo Keizai earnings forecasts for fiscal 2011 fell to 12x from around 14x. Furthermore, the majority of listed companies traded below their book value.

While valuations can be the most powerful market driver over the long-term, investor sentiment can exert overriding influence over the short-term market performance. We expect the market will remain sensitive to key issues, including the crisis at the Fukushima nuclear power plant, the electricity shortage in the greater Tokyo Metropolitan area and volatility in the currency markets.

Although it is too early to fully assess the impact of the on-going nuclear power plant crisis and the power shortage on corporate earnings and macro economic fundamentals, we feel that the Bank of Japan’s policy response and the G7’s concerted intervention in the currency markets have managed to stabilise investor sentiment.

In comparison to previous disasters, authorities in Japan have responded quickly to mitigate the adverse economic and financial effects of the earthquake. The Bank of Japan injected ¥15,000bn ($180bn) into money markets and doubled the size of its asset-purchase program to ¥10,000bn, providing a total of ¥40,000bn in a bid to stabilise the financial system.

Furthermore, concerted intervention by the G7 prevented the yen from strengthening after it rose to a record high of ¥76 against the dollar. As the near-term risk of yen appreciation appears to have receded, a trading range of around ¥79-¥81 is within market expectations.

Ed Merner

President of Atlantis Investment Research Corp

Consumer spending has been impacted since the area most affected includes Greater Tokyo which accounts for more than 40 per cent of Japanese GDP. Stores, excluding supermarkets and convenience stores, are mostly empty and retail sales have dived. We think consumer spending, although recovering from the lows of the last week, will take many months to get back to pre-earthquake levels.

Many companies are also reporting parts shortages and it may take some time before production returns to normal. We expect to see a sharp drop in industrial production and also project depressed GDP growth for the six month period ending in September 2011. Thus it is going to be very hard going for the next six months; consumers are not going to be buying much and the general mood will take some time to recover.

The stockmarket dived in the first few days following the earthquake, falling 16.3 per cent at one point, though it has now recovered somewhat. Many overseas investors have been aggressive buyers, presumably in the belief that the worst had passed and that the market had been oversold. But the bounce has already come and some traders are now cashing in on their profits. Is this the time to be throwing money into Japanese equities, or have you missed your chance to buy at bargain prices?

We think that the Tokyo market is now returning to normal and that many investors have not yet factored in the expected costs associated with rebuilding the economy, projected GDP losses, production losses and the current slump in consumer spending. We think the market will at best move sideways in a band of plus/minus 10 per cent for the time being.

We do believe that for long term value/growth investors this is a good time to selectively pick up bargains but we suggest buying slowly and averaging down in the coming weeks and months, buying on weakness where possible. Japanese stocks look cheap if one is willing to project out a few years and believes the economics/earnings will come through as expected but maybe a year late.Japan usually does well after a crisis and often bounces back sooner than expected.