Looking at the Economic Impact of Japan’s Earthquake
It has been almost a month since Japan was hit by the most devastating earthquake in its history. The ensuing tsunami that swept through Japan’s eastern coast is expected to cost as much as $25 trillion yen ($309 billion) and will cause Japanese Gross Domestic Product (GDP) to decline by about 0.5%, according to figures released by the Japanese government . To put those numbers in context, that is nearly four times the cost of destruction caused by Hurricane Katrina. In addition, perhaps the least known factor is what will happen with the nuclear situation in Japan. While there are still many unknowns, let us focus on two seminal questions we should be asking:
- Did the earthquake and resulting tsunami cause significant and/or permanent change to the economy or capital markets?
- How can investors position their portfolios as a result?
Society in trauma: Economy intact
Potentially, if Japan’s GDP declined by 5.0% (a more realistic outcome in our opinion), the impact to global GDP growth would still be no more than 0.5%. Moreover, the global economic recovery, however modest, won’t be knocked severely off track by the events in Japan.
There may be some industry effects that have a longer-lasting influence, most notably in technology. Japan supplies many of the complex components in technological devices, such as semiconductors, and as a result, global supply chains may be affected temporarily. Substitutions exist in other Asian nations, but they are few and far between. We expect recovery to be swift in this area.
Can the phoenix rise from the ashes?
One question we asked our managers is whether the rebuilding effort coupled with stimulative action, could spur growth and revitalize Japan’s sluggish economy and stock market. The general consensus seems to be that reconstruction will provide a short term boost to Japan’s economy, but will add further fiscal pressures to the already overburdened government balance sheet. Japan must also contend with the realities of its aging demographic, persistent deflation and government debt load to alter its long-term prospects.
What should investors do?
Should investors sit this one out and wait for more information before re-investing? There are understandable concerns around the nuclear issues and what impact they might ultimately have. There are political pressures that cause further uncertainty. In the words of Yogi Berra, “Predictions can be tricky, especially when you’re talking about the future.”
What will happen if you stay invested? We don’t know for sure, but we do know that well-diversified global portfolios give investors the opportunity to participate in the upside and offer potential protection on the downside. If you invest actively, trust your managers to navigate the constantly changing environment and take advantage of more nuanced industry effects.
Today, it is simply too risky to play the market timing game and we suggest positioning your clients for likely probabilities, not possibilities.
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Nikkei 225 is a stock market index for the Tokyo Stock Exchange (TSE). It has been calculated daily by the Nihon Keizai Shimbun (Nikkei) newspaper since 1950. It is a price-weighted average (the unit is yen), and the components are reviewed once a year.