Article written by Prieur du Plessis, editor of the Investment Postcards from Cape Town blog.
The great Tohoku earthquake that hit Japan last Friday (11 March) and the terrible devastation resulting from the subsequent tsunami still need to hit home in the financial markets.
The best way to analyse the current situation is to look at what happened in the financial markets after the Kobe earthquake on 17 January, 1995. The Nikkei 225 held up reasonably well in the first day or two after the quake but was down 8% a week later. After several failed rallies the Nikkei eventually bottomed in June that year, marking a fall of 25% since the quake.
Source: I-Net Bridge.
The S&P 500 hardly moved on the news of the quake and continued to power ahead.
Source: I-Net Bridge.
The yen initially faltered, succumbing by 1.4% against the U.S. dollar but the latter bore the brunt of the quake to reach a bottom 18.3% lower against the yen and 13.4% against the reconstructed euro in April 1995.
Source: I-Net Bridge; Plexus Asset Management.
Precious-metal prices (gold and platinum) were unfazed by the earthquake but gained strongly with the sell-off of the U.S. dollar. Industrial metal prices were severely hit, though, sinking by approximately 17% to a low in May 1995.
Source: I-Net Bridge; Plexus Asset Management.
Global bonds rallied immediately after the earthquake, ending the bear market that commenced at the end of 1993. The bull market in global bonds continued into 1996.
Source: I-Net Bridge; Plexus Asset Management.
Mark Twain once said that history does not repeat itself, but it does rhyme. But let us look at what may be different this time.
The impact on the global economy as a result of the Tohoku earthquake is likely to be devastating on Japan’s economy as the Tohoku region contributes around 8% of Japan’s GDP. Japan’s relevance in the global economy is significantly smaller than it was in 1995. In 1994, prior to the Kobe earthquake, the country’s GDP was 17.9% of the world GDP. In 2009 Japan’s economy shrank to 8.7% of the world GDP, resulting in its relevance falling by more than 51%. China’s economy, on the other hand, contributed 2.1% to the world GDP in 1994 and grew to 8.6% of the world GDP in 2009, and we know China surpassed Japan’s economy in 2010.
Source: World Bank; Plexus Asset Management.
The aftershocks on the East Asia and Pacific region as a whole are also likely to be much more muted than in 1995. In 1994 China contributed only 7.8% to the region’s economy, while by 2009 it surged to 35.3%. India’s contribution more than doubled to 9.3% since 1994. On the other hand, Japan’s contribution fell from 67% to 35.9% in 2009.
Source: World Bank; Plexus Asset Management.
In 1995 the rebuilding of Japan was spearheaded by public investment spending but the Japanese policy makers are hamstrung in 2011. I quote from an article by Dismal Scientist titled “Macroeconomic Ramifications of Japan’s Earthquake”.
“Fiscal response constrained
Japan’s impressive rebound from the 1995 earthquake may not be repeated in 2011. In the immediate aftermath of the 1995 Kobe disaster, GDP expanded 0.9% q/q, predominantly driven by a 1.8% q/q increase in government consumption. Growth remained strong in the subsequent two quarters as the rebuilding effort gathered momentum, with public investment expanding more than 15% in the subsequent 12 months.
However, the fiscal constraints faced by Japanese policy makers in 2011 will inhibit such a profligate response. Finance ministry officials have indicated a fiscal stimulus package is currently being developed, using discretionary funds from the current year’s budget. The expensive and lengthy reconstruction task will add significantly to the nation’s already very high debt load − government debt-to-GDP is already the highest in the world at over 200% − and pressure Japanese policy makers to impose fiscal austerity measures in coming years. As such, the public purse is unlikely to fulfil the role of growth generator to the same extent in the wake of the 2011 disaster.”
My conclusions are therefore:
- It is unlikely that the yen will rise substantially against other hard currencies. In fact, it may weaken due to increased credit risk premium.
- While downside pressure may be exerted on the U.S. dollar, it will be muted.
- It is unlikely that the world economy will be severely hit by the disaster. My estimate is that around 0.5% will be shaved off world GDP in 2011 with the brunt in the 1st and 2nd quarters this year.
- Metal prices are likely to continue to be suppressed in the short term but not as severely as in 1995. All other things being equal, I expect metal prices to rebound handsomely towards the end of the 2nd quarter.
- The slide in Japan’s equity market has only just started.
- Global bond prices are likely to firm up a touch in coming weeks as I expect long rates to soften gradually.
- Precious-metal prices are likely to gain slightly more as a result of a somewhat weaker U.S. dollar than real physical demand.
- I do, however, foresee further downside (10%) in global equity prices to more realistic levels, reflecting the underlying fundamental factors.
My conclusions do not take into account the current volatile situation in the MENA region. Any worsening in the situation there, combined with the financial aftershocks of the Tohoku earthquake, is likely to lead to a possible implosion of the world economy and the resultant chaos in financial markets.
Great Tohoku earthquake: impact on global markets was first posted on March 15, 2011 at 10:10 am.
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