At 2:46pm on Friday March 11th, a magnitude 8.9 earthquake occurred off the Pacific coast of Japan, about 130km East of the coastal city of Sendai. The earthquake caused a 10m high tsunami that has devastated coastal areas along the North East Tohoku coastline.
The Tohoku earthquake has been devastating. The US Geological Survey has estimated its magnitude at 8.9, making it one of the largest earthquakes since records began. While Japan is used to seismic activity and buildings are engineered to withstand powerful earthquakes, the power of this quake - and particularly the 10 metre high tsunami it produced - has caused enormous damage and loss of life.
Pictet Asset Management Strategy Unit - Macro View
It is still too early to estimate the damage. However, economic effects from natural disasters typically have short-term negative impact and a positive impact in the medium to long-term from the subsequent rebuilding of infrastructure.
Short-term: the biggest impact will be on second quarter GDP. The region affected by the Tohoku earthquake, compared with 1995 Kobe earthquake, is less industrialised although it does contain a large number of IT component firms. Given the still early phase of the Japanese recovery and the corresponding low capacity utilisation rates, it seems that impacted companies will be able to relocate their production without too many difficulties.
Medium-term: infrastructure that has been destroyed will be replaced in the medium term. One could expect an abnormal expansion in GDP components from this activity, such as residential investment (by households), in capital expenditure (by corporates) and in public investment. Any recovery in GDP typically tends to occur 2 to 3 quarters following a disaster.
Fiscal Policy
Around a month after the 1995 Kobe earthquake the government announced supplementary spending of JPY3tn. We anticipate a similar budget extension will announced in the coming weeks.
Monetary Policy
The negative short-run impact on activity will force the Bank of Japan (BoJ) to adopt additional easing measures. The BoJ has already announced it will double its asset purchase facility from a current JPY5tn to JPY10tn. A coordinated move is also likely when the Government announces details of its rebuilding program. We expect monetary policy to remain very loose for the coming quarters.
Currency
Following the Kobe earthquake in 1995, the yen appreciated by some 20% on the repatriation of foreign assets by Japanese insurance companies. While this short-term risk is of course present, we think it remains limited for two reasons:
i) The BoJ will do everything to maintain ample liquidity conditions with very loose monetary policy.
ii) It is likely that a lot of foreign assets repatriation has already occurred following the 2008 financial crisis.
In the medium-term, ample liquidity conditions may be negative for an already very expensive yen.
Market Impact
Japan
The Japanese markets dropped sharply at the open on Monday 14th, the first trading day after the earthquake. Many stocks remained limit-down throughout the day – particularly if there was a direct impact from the quake, such as Tokyo Electric Power. At the close of trade, the Nikkei 225 had fallen -6.2 per cent and the broader TOPIX index had dropped -7.5 per cent. The weakness was particularly pronounced in the smaller stocks with the TOPIX Second Section Index falling -9.5 per cent and the TSE Mothers Index, which typically has significant individual investor activity, falling -17.2 per cent. Tuesday 15th saw similarly dramatic falls with the Nikkei falling -10.6 per cent and the TOPIX index -9.4 per cent. This was the biggest two day drop since 1987.
The media focus is now of course the nuclear reactor at Fukushima. However what has been less publicised is the effect on power generation and distribution in Japan, which is alarming. There are reports of up to three hour power stoppages in some areas of the Tokyo Metropolitan Area and the surrounding eight prefectures. Without clear demand numbers for each of these areas, one can only make a loose estimate what the total GDP impact of this might be, but somewhere around ¥5tn – or 1% of GDP – as of the end of April seems a reasonable guess, if slightly pessimistic. However disruption to Japanese infrastructure could weigh on domestic economic activity for some time, with the eventual size of the rebuilding programme certain to be immense but as yet unquantifiable.
Global
The economic ramifications of last week´s earthquake have taken several days to manifest themselves in global markets. US markets in particular have been slow to reflect the potential impact of Japan´s misfortune. The very obvious implications for Power generation - both nuclear and non - in Japan saw Asian coal stocks move higher in the expectation of greater Japanese utilisation of thermal coal to replace shuttered nuclear capacity. Germany has ceased production at several older nuclear facilities following the Japanese situation, and upcoming nuclear projects in the UK and US are suggested to be in doubt, sending related stocks sharply lower.
The impact on complex global supply chains has yet to be fully understood, particularly in the electronics markets where Japan still plays a key role in the supply of components and printed circuit boards: shortages could lead to disruption across a large range of consumer and industrial products, across all geographies.
Global Sector Key Impacts
Overall, the short-term impact on commodities is expected to be negative due to the temporary shut down or loss of production activities. In the medium term, this is likely to reverse as production recovers and reconstruction commences. The hardest hit has been the uranium market, with the potential negative sentiment around future nuclear capacity hitting the uranium price and uranium producers.
The nuclear question appears to be a major global theme emerging from the catastrophe. Germany, which has a large fleet of nuclear plants, today announced it was taking seven off-line while it reviewed its intended goal (pre Japan –Crisis) to extend the plants, in some cases beyond 45 years life.
Much of the damaged property in Japan was constructed from timber and it appears that this will be incrementally positive for timber prices. A number of paper mills have halted production, but this appears temporary.
The disruption of electrical components (especially those related to semiconductors) has not yet been established but could pose a risk to the total supply chain. Although the majority of Japanese companies have very localised production in Japan (i.e. Japan sites for Japanese demand) therefore risk, at the present time, appears to be contained.
The implication for automakers has been severe, a shutdown of most plants operating in Japan and also a shutdown of equipment makers plants, which in turn supply Japanese companies overseas. This has a limited knock-on effect to those European car makers with shareholdings in Japanese automakers.
In conclusion it was almost inevitable that markets would fall significantly following the disaster. We are regularly looking at our portfolio and monitoring the situation with caution. Furthermore we seek to understand any risks which could derail the tentative global recovery.
