GLC Asset Management Group recently offered some comments on the Japanese earthquake and current market conditions. I’ve included some highlights below:
What We’ve Seen
As with most large scale natural disasters or major geopolitical shocks, capital markets are responding with a move to more defensive positions, selling off riskier assets. So far we have seen:
- A sharp sell-off in the Japanese stock market (Nikkei decline of over 15 per cent over past two days)
- A moderate pullback in global stock markets
- A shift toward “safe haven” assets
- U.S. Treasury bond yields down (bond prices up)
- Gold price up
- Commodity prices down
- Oil off approximately $4 per barrel (but remains up so far this year)
- Stocks linked to property and casualty insurers, the Japanese capital markets and the nuclear industry (e.g. GE, uranium stocks) have been particularly hard hit as would be expected under the circumstances.
What We Expect – Economy
The Japanese economy will take a hit this year due to severe disruptions in supply and infrastructure, but is expected to rebound quickly as rebuilding activity and support by the Bank of Japan provide a boost to economic growth.
We expect the impact on the global economy will be modest. Japan represents approximately 8.7 per cent of global gross domestic product (GDP) as of 2010 (according to the International Monetary Fund (IMF)). While production and supply disruptions are likely to be felt globally, much of that production could be sourced elsewhere, especially due to excess capacity in North America. For example, even if the impact of the earthquake knocked 1.5 per cent off Japanese GDP (a significant amount), the effect on the global economy would be less than 0.2 per cent.
The key economic impact will likely be felt within specific sectors and industries, rather than at the global economic level. As with other times in which economies experience turmoil, this will hurt certain industries, while creating opportunities for others.
What We Expect – Capital Markets
If it’s one thing investors hate, it is uncertainty. As following almost all natural disasters, the effect on capital markets is usually short-lived. In this case, the disaster is still playing out, while investors were already feeling a bit unsettled by the situation in the Middle East and the emerging global economic recovery. Negative sentiment and investor concern might take a bit longer to ease.
In general, we expect to see the following:
- Commodities prices: While the demand for oil might be lower over the short term, potential supply risks in the Middle East have the opposite affect on oil prices. As reconstruction gets underway, we would expect an increase in demand for a wide range of raw materials.
- Stock markets: Much of the sell-off so far has been sentiment based, as opposed to reflecting the actual fundamental impact on the actual companies. As the unknowns reveal themselves investor sentiment will become more positive and we expect stock markets to regain strength. The Canadian stock market in particular should fare well, as it is not highly linked to the Japanese economy and we may see investors rotating out of their Japanese equity investment in favour of other jurisdictions, such as Canada and the U.S.
- Bond market: The bond market has been a beneficiary of the flight-to-safety trade so far. We expect yields to remain dampened from their pre-earthquake levels as there is likely to be some residual investor nervousness and expectations for a slight reduction in economic growth.
What Should I Do?
As long-term investors, your best bet is to stick with your long-term investment plan. No one knows how the situation in Japan will play out; however, situations like these are always a reminder to stay focused on your longterm investment goals. They also remind us of the importance of diversification. A well-diversified portfolio is unlikely to be heavily weighted in one or two industries and, therefore, diversification can provide the added benefit of softening the effects of short-term volatility and sharp market pull-backs. While the headlines are scary, the net impact on a well-diversified portfolio has been modest and within a couple of weeks, may even be long-erased as the markets turn their attention back to the broader global economic outlook.
For up-to-date information and resources related to the 2011 Japan Crisis, as well as donation options, Google has set up a page here: http://www.google.com/crisisresponse/japanquake2011.html
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