Asset Allocator’s Soapbox – Japan: when, not if

Hans Hamre, head of global equities at FundQuest, believes it is only a matter of time before the economic sun rises over Japan again.

Notwithstanding the substantial human element, continued evaluation of the impact of the enormous earthquake, the subsequent tsunami and nuclear power disasters need assessment from a cold financial and technical stand point.

The economy has been hit but will gain from reconstruction growth drivers.
Tokyo Electric Power (the operators of the Fukushima site) is currently struggling to regain control of the reactors. Whilst significant progress has been made it is impossible to predict when this race against time will be won.

In any case, Japan’s GDP will be severely impacted in the first half of 2011 and will remain depressed for at least the remainder of 2011. After that, scenarios are hugely dependent on the evolution of the nuclear issue with the worst case being a major contamination having long term and massive implications on public health, food supply and economic activity for millions of people in Japan.

The more optimistic case if this issue can be controlled is that the recovery will accelerate. 

Therefore, given political delays a positive impact should not be expected until at least the last quarter of 2011.

The long term potential structural problems to power supplies and infrastructure generally can not be underestimated. The issue of how the yen reacts will also be pivotal as there is uncertainty whether or not the weakening of the currency caused by additional public spending will outweigh its potential strengthening arising from the capital repatriation to finance reconstruction.

As to the impact on specific industries, property and casualty insurers will undoubtedly be amongst the first losers whilst construction and suppliers will benefit.

Beyond these obvious impacts it is becoming increasingly clear that manufacturing processes requiring components from multiple suppliers are more at risk of being brought to a halt simply because one missing part can block the entire production process. This is particularly relevant for car and electronic manufacturers.

Despite all this, the Japanese market lost just 9% in March which is remarkable given the level of uncertainty. Looking outside of the disaster itself two key themes are critical when selecting managers with exposure to the Japanese economy.

The first is holding companies with a high proportion of international manufacturing and sales operations (the emphasis being on international as opposed to domestic); and secondly, among domestically oriented companies a strong focus on service based companies (which inevitably incurred fewer damages) and companies with strict cost control (which often comes with overseas production) also are likely to benefit.

Therefore it is not a question of if the sun will rise again in Japan but when from an economic stand point.