On Friday, March 11, a massive earthquake that measured 8.9 on the Richter scale hit Japan. The quake hit off the North Eastern coast and caused a 10-metre-high tsunami to hit the coast.
Japan authorities reported there is a nuclear power emergency situation with four million homes without power, following the largest earthquake to hit Japan on record.
Furthermore, the tragedy, naturally, had a huge impact on the Japanese financial markets, which in turn has had repercussions on the global markets.
At one point, the Japanese equity markets saw the worst price plummets since the 1987 crash, despite the the Bank of Japan (BoJ) pumping the system with JPY 15 trillion to stabilise the markets.
Global Custodian spoke to Manish Singh, Head of Investment Services at private wealth management group Crossbridge Capital to assess the short, medium and long term impacts for investors and global custody.
Q: There was a sharp sell-off in Japanese equities, which in turn was replicated to some extent in the global markets. What is your view on this?
A: This was an anticipated reaction and I am not surprised at how prices dropped, especially if you think back to when the Nikkei fell 25% in five and a half months following the earthquake in Kobe in1995. However, what you have to remember is that this was followed by a 56% recovery in prices in the next 12 months.
While I am not surprised at the sell-off, I believe that there will be a strong recovery in the longer term. Natural disasters are a supply shock to the economy and the uncertainty accompanying it often forces investors to chase liquidity and sell stocks and other investments in order to raise cash.
We currently at Crossbridge Capital are not raising our investment in Japanese equity at this time. This is also a result of a cautious approach we have had heading into the month of March on equity as an asset class from a macro economic outlook. However, we do expect a rebound in the Nikkei and will want our clients to take part in it once we have spotted the trend.
Q: How will the events in Japan impact the European and US markets?
A: If we look purely in terms of whether Japan would set world economy back into a recession – No.
Again, by using the last Japan earthquakes impact on the financial markets as a comparison, Japan made up 20% of the world GDP in 1995, now it is only 9%. As anticipated, if the crisis was to shave 3% off Japanese GDP this will lead to a reduction of 0.3% in global GDP — not enough to cause a global recession.
However, the Global economy still has dislocations due to the European sovereign debt crisis and the ongoing upheaval in Middle East and have potential to change market sentiments for reasons other than Japans earthquake.
Japan weighs in at less than 5% of US exports and roughly 6% of US imports, therefore the impact on the US will be limited as well.
The question for Europe will be if Japanese companies will continue to buy European government bonds at the levels anticipated before the earthquake struck. As a result, The ECB will likely rethink their rate stance in light of this event and keep rates on hold at their next meeting.
Q: What kind of an impact will these events have on products such as ETFs?
A: I would like to say that I like ETFs very much. They are a great tactical asset allocation product.
By investing in ETFs, investors can express their view on markets more precisely, over shorter time period (if need be) and not hesitate to take profit. Additionally, they are able to re-enter the same trade without incurring large transaction costs. However, despite this, I wouldnt advise excessive trading. Investors should trade only to express views over a time horizon they have full understanding of. The very liquid nature of ETF investments keeps transaction costs low and ease of execution adds to their benefits.
Q: Would you say holders of Japanese equity and REITs exposed funds need to hold, buy or sell?
A: If you are thinking of adding size, I would advise to not rush so long as the nuclear uncertainty prevails.
If you have taken an unrealized loss on your existing positions, and were not able to cut exposure at the first instance — there is no need to panic and sell immediately either.
If however the markets take another leg down it would be worth thinking of exiting the holding or if you are believer in long term prospect of Japanese equities as we are, add to your position to average your entry cost.
Investors have always found the Japanese market a very challenging one to make money in. It has been a value trap for long time. I believe this supply shock will be inflationary and Japanese equities will do well in a recovery.