Investors take stock of Japan emergency

Transcription

1 Investors take stock of Japan emergency By Tom Stevenson, 18 March 2011 A terrible episode in Japan's history leads to one of the most volatile weeks since the finansial crisis. Please return here regularly for the latest information. 18 March : Update The end of one of the most volatile weeks in world markets since the financial crisis, gives us an opportunity to reflect on the human cost of the devastating earthquake, tsunami and nuclear emergency in Japan. It is impossible for us, thousands of miles away, to imagine the suffering of people directly affected by the appalling events but our thoughts continue to be with them. In parallel with these human concerns, as the week s events have unfolded, investors have attempted to assess their economic impact and adjust their positions accordingly. Inevitably, events of such magnitude have caused extremely volatile markets. "Events such as the terrible Tohoku earthquake in Japan put into perspective our day to day professional focus on economics and investment markets. " Tom Stevenson On Monday, the first trading day in Tokyo since the earthquake, shares fell 6%. On Tuesday, as the extent of the emergency at the nuclear plant in Fukushima became clear, shares fell a further 10%. On Wednesday, they recovered almost 6%. Anxiety about the unfolding situation, especially fear of a nuclear disaster, spread through world markets as each one opened in sequence from Asia to Europe and finally the Americas. However, as progress seemed to be made in Fukushima, a degree of confidence returned to restore relative stability such that by Friday lunchtime world shares were only 2.2% down since the earthquake struck. At the time of writing, the FTSE 100 index was 0.7% higher on Friday morning, with a similar gain being recorded in continental Europe, adding to Thursday s gains as markets regained their poise. In similarly volatile trading in the currency markets, a combination of Japanese investors repatriating assets and speculative buyers betting the Japanese government would not intervene to weaken the yen saw the currency soar in value. The yen broke through a previous post-war high of to the dollar and continued to hit 76. In a bid to stabilise the yen, the G7 agreed on coordinated support for the first time in a decade. This means these global economic heavyweights will sell yen to counteract the inevitable buying pressure from Japanese investors repatriating assets to cover losses. As a result, on Friday, the yen fell to below 81 against the dollar. Oil, a loose proxy for investors' confidence in global growth, has been similarly volatile. The Brent crude barrel fell 5% on Tuesday, before rising to above $115 later in the week the level it was at before the quake struck.

2 To put the week s share movements in context, I looked at how several major markets have performed since the MSCI World s recent post-financial-crisis high on 18 February. These can be seen in the first chart below. Shares in Tokyo have clearly fared the worst losing 17%. The German market, with relatively large insurance and nuclear energy sectors has dropped 10%. Europe as a whole, Hong Kong, the UK and the US have all lost between 5% and 6%. Brazil has fallen 3% and China has held the same level.

3 After such a volatile week, investors will watch closely how the nuclear emergency develops over the weekend. The Japanese market is closed for a public holiday on Monday, giving investors a little more breathing space for a sober assessment of the impact of the tragedy. Tom Stevenson has been blogging on the markets throughout the week and you can read below how the story has unfolded in his updates. 17 March : Update Markets in Europe and the US regained their poise this afternoon despite continuing uncertainty about attempts to contain the nuclear emergency at Fukushima, a rise in the death toll from last week s earthquake and tsunami to 5,600 (with 9,000 still missing) and continuing turmoil in the Middle East. The scale of the catastrophe in Japan has been underscored by snowfalls in the worst affected areas, adding to the misery of those directly impacted by the country s worst ever natural disaster. The FTSE 100 ended 1.75% higher at 5,696, with the Eurofirst 300 index up by a similar margin as investors were reassured by a strong opening on Wall Street where shares are 1.4% stronger at the time of writing. US shares responded to better than expected inflation and jobless figures, allowing the S&P 500 to bounce off Wednesday s 2011 low.

4 Despite the firmer tone, the underlying mood in global markets remains one of nervous volatility. A dramatic swing in the yen/dollar exchange rate overnight highlighted investors febrile state of mind this week as they struggle to determine what the financial implications of the Japan crisis will be. At one point, in an echo of the flash crash in the US stock market last year, the value of the yen soared to 76 to the dollar before retreating as quickly as it had risen to 79 again. As well as events in Japan, investors are weighing the impact of ongoing unrest in both Libya and Bahrain which continued to push the oil price higher, up 3% to $114 a barrel for the Brent contract on supply fears. In other energy markets, the cost of natural gas soared as traders bet that Japan would move into the market to replace lost nuclear power generation capacity. 17th March : Update With snow falling over north eastern Japan, the human cost of the ongoing Japanese crisis is even more acutely evident today and our thoughts continue to be with those directly affected by the terrible events since last Friday. In the markets, the main action shifted overnight from equities to currencies, with an extraordinary movement in the yen/dollar exchange rate, which in a matter of a few minutes broke through a previous post-war high of to the dollar (set in April 1995) and did not stop until it had reached 76, a massive move by the standards of the currency market. The yen has been rallying against the dollar ever since last Friday s earthquake amid expectations that Japanese companies will be obliged to repatriate foreign assets in order to fund the rebuilding effort in the stricken north east of the country. Insurance companies, big holders of overseas assets such as US Treasury bonds, are also expected to pull money back onshore in order to meet claims. But the speed of the hike in the value of the yen overnight was of a different order altogether from what might be expected from an orderly shift of assets from other currencies into yen. Rather, the finger was pointed at speculative traders emboldened by the belief that the Japanese government would not step into the market to hold down the value of the yen. This belief was confirmed by the speed with which the yen subsequently fell back against the dollar. At the close of trading in Tokyo, the yen stood at A rising yen is a further hurdle for Japan s embattled corporations to clear because it raises the price of its exports in overseas markets. In a bid to stabilise global currency crosses, France has convened a conference call this evening of G7 finance ministers, prompting expectations that a co-ordinated intervention may be activated. Fidelity s analysts in Tokyo are currently working with portfolio managers to ascertain the impact of the ongoing rise in the value of the yen on Japanese companies. Although the situation remains extremely fluid, they believe the auto, heavy machinery and electronics sectors are most at risk currently while domestic sectors such as telecoms and software are more protected from currency movements. The rise in value of the yen, coupled with ongoing fears for the stricken Fukushima nuclear plant, took their toll on Japanese shares which fell sharply in early trading. By the close, however, the main Topix index was

5 only 0.8% lower while the Nikkei 225 index closed 1.4% down. Compared with the indiscriminate selling of previous days this week, the sector impact was more considered on Thursday, with oil & coal, air transport, electric power & gas, pharmaceuticals and metals all posting gains on the day. Food and financials were the big losers. Meanwhile, the Bank of Japan continued to pump in extra liquidity to stabilise markets bringing the total injected this week to 34trn. Following Wednesday s heavy falls in Europe, a firmer tone was struck this morning with the FTSE 100 and Germany s DAX both up by around 0.8% at the time of writing. This was despite ongoing concerns about developments in the Middle East, as conflict in both Bahrain and Libya dragged on into another day. 16th March : Update At the end of another extraordinary day in the markets, Europe s initial relief at the bounce in Asia evaporated to leave major bourses well under water again. The FTSE 100 closed 1.7% lower while Germany s DAX index fell 2%. The dramatic U-turn followed comments from the EU s energy commissioner, Guenther Oettinger, describing the Japanese nuclear emergency as "out of control". It soon emerged that his remarks were not based on any new information but the damage had already been done to an increasingly skittish market. US markets picked up on the deteriorating sentiment in Europe and, at the time of this update, the S&P 500 index is 1.3% lower and the Dow Jones Industrials index is off 1.5%. Nervous investors have increasingly opted for safe haven investments again, with yields on US Treasury bonds falling as prices rose. The Swiss franc is in favour. Meanwhile the other concerns that investors had pushed to one side while they focused on Japan were kept on the boil. Disturbances in Bahrain were reflected in a firmer oil price, now trading at around $111 a barrel. Sovereign debt yields in the eurozone were hit by Moody s downgrade of Portugal and a sale of debt was only possible at a higher yield than previous auctions. Things had looked very different earlier in the day when a leading indicator in China suggested that growth in the world s key emerging market remained on track while comments from the Federal Reserve about the state of the US recovery had boosted sentiment. The switchback ride of investor sentiment today has confirmed the dangers of knee-jerk responses to shortterm news and the need to stand back from apparently important events which are soon superseded by information from another quarter. For investors wondering how best to position themselves during this period of great uncertainty some Fidelity analysis of recent market moving events provides a salutary warning against becoming too transfixed by newsflow and forgetting that in the long-run markets are driven by fundamentals. An analysis of the best performing sectors in the 12 months following events such as the 9/11 attacks, Hurricane Katrina and the Kobe earthquake showed that the dominant influence on markets was the broader global economic picture. So in 2001/2, for example, one of the best performing sectors was tobacco, an industry that had been

6 forgotten during the technology bubble. In 2005, after Katrina, the winning sectors were mining and real estate, a consequence of the boom in China and low interest rates. Watching the fundamentals not the 24 hour news channels remains the key to successful investing. That said, attention will once again shift overnight to markets in Asia to see if investors have the nerve to hold onto Wednesday s recovery. 16th March : Update The market s tendency to focus on one issue at a time has been illustrated by today s price movements in Europe. After stabilising early on following the sharp bounce back in Asia overnight, the main European stock indices have wilted again as investors turned their attention to the deteriorating situation in the Middle East. At lunchtime, the FTSE 100 index was about 40 points lower, while the DAX in Germany, which fell more sharply on Tuesday, was broadly flat. News of ongoing disturbances in Bahrain has reminded investors that Japan is not the only influence on markets at the moment. To date, trouble in North Africa has been situated in countries with only a relatively small impact on global oil supply, but the intervention of Saudi Arabia in Bahrain and comments from Iran have upped the ante in the region. The oil price, which had retreated from recent highs on expectations of lower demand from Japan, pushed higher to $ for the Brent contract, as investors focused on potential supply disruptions. The fact that markets have only fallen slightly on these developments is an indication of the two way pull on stocks at the moment as evidence pointing to an ongoing global recovery also accumulates. Although the Federal Reserve left US interest rates unchanged this week, for example, it commented that recovery in America is on a firmer footing. That is an important reminder that the US and China are the key determinants of global GDP growth today. A further potential fillip for markets is the fact that events in Japan probably push further back the date when the interest rate cycle turns upwards, even if inflation figures out of Europe today confirm that price pressures remain a worry. Futures suggest that UK rates might not move until August (compared with earlier expectations of a May hike) with a second move not until early next year. The volatility of markets today is a further illustration of the need to take a long-term view when investing through periods of upheaval. Although there is a temptation to try and time short-term market swings, the reality is that it is a lot more difficult than it looks with the benefit of hindsight. It is also extremely risky because our research shows that the cost of missing even a few of the best performing days in the market can be significant. For example, we looked at the returns that would have been achieved by remaining fully invested in the market between 1991 and the beginning of March 2011 and compared them with those that would have been achieved by an investors who missed the best days in the market as a result of failing to get back in the market in time for bounces. The fully invested return over that period was 6.5% a year, more than twice as much as the 2.9% achieved by an investor who missed just the best 10 days during that period. An investor who was out of the market would have actually lost 3.3% a year on average over the period. These are massive differences when compounded up over 20 years.

7 16th March : Update In the absence of further bad news from north eastern Japan, Asian markets have bounced back overnight, deeming Tuesday s sharp falls to have been an over-reaction. In Japan, hardest hit by the sell-off at the beginning of the week, the Nikkei 225 benchmark index rose by 5.7%, partially reversing the 10.6% fall on Tuesday and the 6.2% decline on Monday. It was the first positive day for Japanese stocks in the past five. Elsewhere in Asia, the smaller declines on Tuesday were also reversed on Wednesday as investors took the view that the wider economic impact was likely to be containable. Asian markets took their tone from Wall Street s relatively measured reaction on Tuesday when early falls were pared. Despite the market reaction, the crisis in Japan is far from over. Overnight there were further reports of fires at the stricken Fukushima nuclear plant. There remains a high degree of uncertainty. The turnaround in fortunes for the Japanese market underscores the dangers of knee-jerk responses to fastchanging events. Although hindsight suggests that nimble investors might have been able to make profitable moves out and back into the market, the reality is that markets move more swiftly than most investors are able to and they do so unpredictably. The more important question for investors now is what happens in the medium term as investors turn their attention back to the wider global picture and do so in a more risk-averse frame of mind. The indiscriminate nature of the market sell-off on Tuesday indicates a heightened sense of nervousness which is unlikely to be eased by a shift of focus back to other parts of the world which have been eclipsed by Japan in recent days. The Middle East continues to be a worryingly unstable region, with a state of emergency declared in Bahrain after troops from neighbouring Saudi Arabia were invited in to help quell unrest in the small but strategically important Gulf kingdom. The situation in Libya remains volatile. Attention is likely to refocus on the eurozone too. The region s sovereign debt problems were returning to the investment radar last week before the Japanese earthquake and tsunami distracted attention. The key question is the extent to which events in Japan hold back the global recovery that had fuelled a two year market recovery since March So far, few economists have pared their forecasts but reduced expectations would most likely not be taken well by a market which some observers believed was ready for a pause. However, the most important drivers of global growth the US and the major emerging markets such as China need not be materially held back by what has happened in Japan. Indeed, if one response is to maintain interest at low levels for a bit longer than previously expected, markets could even benefit. The Federal Reserve this week kept rates on hold at near zero levels and expectations for a May rate hike in the UK have receded. In Japan there is likely to be a short-term hit to GDP followed by a reconstruction-related surge of activity. More important for global markets is the extent to which the Japanese decide to liquidate their foreign holdings in order to fund the rebuilding effort at home. This could hit US Treasuries in particular, but the search for yield sent Japanese investors further afield in recent years so the impact could be felt more widely. There will be a further update later this morning after the European markets have had a chance to reassess

8 the situation Update. After shares in Tokyo recorded the third steepest fall on record, it was almost inevitable that European and US markets would follow. As engineers at the Fukushima nuclear plant battle to contain the damage to its six reactors, investors across the world have sought to assess the immediate and longer-term impact of this appalling event. Shares on Wall Street opened around 2% lower but immediately stabilised above that level. In London, a similar fall as the market opened was gradually recovered and the main index looks set to end the day around 1.3% off. Europe has been hit harder, with German shares suffering the worst, falling 3%. The country's large reinsurance sector could be liable for major losses caused by the quake and tsunami and a the announcement of a review of the country's nuclear power policy prompted falls in the shares of companies operating nuclear power stations in Germany. The potential for the disaster to slow the Japanese, Asian or even global economy knocked commodity prices. Brent crude oil fell more than 3% per barrel to $110 along with other energy prices. While copper and agricultural commodities were also lower. This volatile market reaction is understandable given the circumstances of events in Japan and nervousness caused by uncertainty elsewhere such as in North Africa. The challenge for investors in situations like these is to compartmentalise their reactions, keeping the natural human responses of sympathy for those directly affected separate from an assessment of the wider financial and market implications. It is not at all clear, for example, that the events in Japan in recent days, bad as they have been, represent a serious threat to the global economic recovery. The earthquake and its aftermath have been devastating. The uncertainty around the Fukushima nuclear plant is worrying. But investors must ask whether the Japanese stock market is really worth 20% less than when it closed on Friday and be level-headed in their own reaction to this appalling natural disaster. Update Markets across Europe have picked up on widespread risk aversion in Asia this morning, with sharp falls in stock markets as investors struggle to assess the implications of the seemingly deteriorating situation in Japan. Further damage to the Fukushima nuclear plant in north eastern Japan following last Friday s earthquake and tsunami has apparently increased the risk of a serious radiation escape and raised the possibility that the economic damage may be less contained than investors had previously believed. Markets across Asia responded to the worsening outlook by marking shares sharply lower. Hardest hit, inevitably, was the Japanese market itself with a 10.5% fall in the Nikkei 225 benchmark. Japanese equities have lost around a fifth of their value in two days. The biggest impact has been within the insurance sector, which has fallen by 14.5% over two days. Other big fallers have included the other finance sector (down 13.2%) and the oil & coal sector (12.9% lower). The sole rising sector was construction, which is seen a beneficiary of the reconstruction effort that will follow the disastrous events of the past few days.

9 In contrast to Monday s more calculated response in which investors attempted to selectively pick the situation s winners and losers, the tone of Tuesday s trading appears to have been a more widespread shift away from risky assets. Across the Asia region, shares closed lower but less dramatically than in Tokyo. Sydney lost 2.1%, Seoul was 2.4% lower and India fell 1%. China s markets were also hit, with Taiwan losing 3.4% and Shanghai 1.4% lower. The fixed income markets reaction has been relatively more muted, with a flight to quality being the principal driver. Major government bond markets have rallied significantly with the exception of the Japanese Government bond market which is slightly lower after a strong rally on Monday. Within Europe, Germany was the most affected (down nearly 4%) as Chancellor Angela Merkel put on hold plans to extend the life of the country s nuclear reactors but other markets were caught in a generalised flight from risk assets. The FTSE 100 fell around 3% in morning trading. The challenge for investors in situations like these is to compartmentalise their reactions, keeping the natural human responses of sympathy for those directly affected and fear separate from an assessment of the wider financial and market implications. It is not at all clear, for example, that the events in Japan in recent days, bad as they have been, represent a serious threat to the global economic recovery. The response of markets across Asia and Europe would only be justified if this were the case. Reacting in a knee jerk fashion to bad news is invariably a recipe for increasing long-term losses because markets move more quickly than individual investors are able to and so they risk selling too late and failing to benefit from any bounce in markets which can follow a big sell-off. It is important at times like these to keep a clear eye on our long-term investment objectives and not to be bounced out of these by short-term fluctuations in the market, unsettling as these might feel at the time. Update The situation in Japan took a turn for the worse overnight as fresh explosions at the Fukushima nuclear plant appeared to release radiation into the air. Markets reacted swiftly, pricing in worst fears and sending the Japanese market 10.5 per cent lower by the close. Other Asian markets also fell heavily. The Japanese market has lost around a fifth of its value in two days as the country struggles to come to terms with its worst ever earthquake and tsunami. The Japanese prime minister Naoto Kan has appealed for calm, advice which should obviously apply to investors as well, hard as that feels at times of great uncertainty such as these. At Fidelity, our primary concern is to support our customers through this difficult period and one of the primary ways in which we can do this is via communication of our understanding of the unfolding situation through the web.

10 14 March 2011: Events such as the terrible Tohoku earthquake in Japan put into perspective our day to day professional focus on economics and investment markets. Our initial thoughts are obviously with those directly affected by the earthquake and tsunami in north-eastern Japan. The initial response by investors to the catastrophic events of last Friday is an indication of the scale of the disaster. The Nikkei 225 index in Japan closed more than 6% lower on Monday, the first full trading day since the earthquake, having already fallen 1.7% last Friday. That market fall already matches the 8% decline in the Japanese market in the first five days after the Kobe earthquake of 1995, which most observers are using as the best indicator of the likely financial impact of the latest events. It is, however, notable that other markets in the region have been affected to a much smaller degree. The FTSE All Share World index fell by less than 0.5% and there has been little indication of flows into havens such as the Swiss Franc. A simple comparison with Kobe in 1995 suggests that the market has been quick to factor in the likely impact, although, as the chart shows, the knock-on impact on markets can be extended. Within six months of the earlier earthquake the Japanese market had fallen by more than 20% before recovering its previous level a year or so after the event. There are, however, important differences. Firstly, the Kobe earthquake happened when the Japanese market had already been falling for six months. Japanese investors were coming to terms with the fact that the country s economic boom during the 1980s was really over. The Japanese market was much more highly valued in 1995 than it is today a price-earnings ratio of 53 times, according to Nomura, compared with just 14 times today. Monetary policy was tight at the time and the government s response was much slower than it has been this time the injection of liquidity by the authorities has taken people by surprise. The area affected by the earthquake represents a relatively small part of the Japanese economy 4% of GDP and is less critical in infrastructure terms than Kobe, which is a major Japanese port. A key difference this time one which has dominated the news coverage over the weekend is the damage to nuclear reactors, which remains a major uncertainty. A major economic impact in the weeks ahead is likely to be a planned programme of rolling power cuts which will affect industrial production. Estimates of car production, for example, are already being scaled back. One of the reasons why the Japanese market has fallen so sharply is fears over the impact of the earthquake on the level of the yen. Repatriation of funds to pay for the rebuilding of the country could put upward pressure on the exchange rate, which would be a negative for the country s exporters. The disaster has come at a critical time for Japan. The recovery from the financial crisis was experiencing a lull but growth was expected to pick up this year. It is likely that there will be a slowdown in GDP growth in the short-term and the recovery could be postponed until the second half of Further out, however, increases in government spending and the significant relief effort will act as a stimulus to the construction industry and capital investment. Unsurprisingly, this was reflected in the price of companies in the building sector on Monday, which rose in value. Some defensive sectors such as pharmaceuticals and food also did better than the market as a whole.

11 The Japanese earthquake happened at a difficult moment for global markets. Last week also saw the eurozone coming back into focus as a key concern for investors. The situation in North Africa and the Middle East deteriorated and worries about Chinese inflation were a distraction too. At times like this, it is important for investors to avoid the temptation to act hastily and to take their eye off their long-term goals. Modern 24 hour rolling TV news coverage has the power to bring vivid images into our homes as never before. When confronted by these it is all the more important, while remembering our shared humanity, to also keep a sense of perspective. Note the value of an investment and the income from it can go down as well as up, so you may get less than you invested. The ideas and conclusions in this column are the author's own and do not necessarily reflect the views of Fidelity's portfolio managers. They are for general interest only and should not be taken as investment advice or as an invitation to purchase or sell any specific security. Past performance is not a guide to what may happen in the future and the figures and returns in this article are purely to illustrate the author's points.