Worse than Kobe, in more ways than one

Don't expect Japan's stockmarket or the economy to recover as quickly as they did after the 1995 Kobe earthquake.
Nuclear emergency threatents Japan's recovery
Nuclear emergency threatents Japan's recovery

On the first working day since the Tohoku Pacific earthquake shook Japan, the world’s third-largest economy opened to blackouts and continued efforts to locate unaccounted-for people. At midday, Tokyo Electric Power (Tepco) announced that a third reactor had lost its cooling capacity, which could lead to overheating and an explosion similar to two blasts at its other reactors.

But the Bank of Japan and the financial industry as a whole worked hard to exude calm in the aftermath of the worst earthquake and tsunami in living memory for the people of Japan. We wrote yesterday about how bankers went back to work on Friday. On Monday, the Bank of Japan offered to pump a record $183 billion of liquidity into money markets.

Nonetheless, Japan’s main index closed down 6.2%. The benchmark Nikkei 225 stock average dived 633.94 points, or 6.18%, to close at 9,620.49 — below the psychologically important 10,000 line. The broader Topix index was down 7.5%. Thirty-two of 33 Topix sub-indexes ended in negative territory. The last time Japan’s markets tumbled so severely was on October 24, 2008, immediately after the failure of Lehman Brothers.

Not surprisingly, onlookers are searching for some sort of benchmark for forecasting equity market performance in the next couple of weeks. The Topix and the Nikkei Average fell 8% in the first five days after the Kobe earthquake in 1995 before rallying 5% during the following 10 days — meaning it dropped just 3% during the 15 days following that earthquake.

But a similar replay might be wishful thinking. The unprecedented tsunami and the potential for a nuclear meltdown mean that this disaster might affect Japan’s economy and markets more so than Kobe did. “Considering the major disruption to infrastructure such as roads and electric power-generation facilities, we think the short-term impact on economic activity could be greater than after the Kobe earthquake,” wrote Nomura analysts on Monday.

The Kobe earthquake caused ¥10 trillion in damage, or about 2.5% of Japan’s gross domestic product, yet the economy recovered quickly thanks in part to the government adopting an extra budget worth around ¥3 trillion. This time, there are more variables at play.

“All natural disasters follow a similar pattern in terms of their economic impact and the Japanese earthquake is unlikely to be any different from say the Kobe earthquake in Japan in January 1995 or the Boxing Day tsunami in Asia in 2004. The initial impact is negative as production is disrupted as a result of damage to factories, the power supply, transport infrastructure, confidence, and to homes, which means workers are focussed simply on survival. This then gives way to recovery as rebuilding kicks in and production returns to normal,” explained Shane Oliver, head of investment strategy and chief economist for AMP Capital Investors.

“However, it is still very early days in assessing the damage and there are some reasons to be a bit more concerned this time around. First, it’s the tsunami which has caused most damage this time, wiping away whole towns and parts of cities, as opposed to just earthquake damage to buildings, roads, etc. This also means the rescue operation may be more involved as will be the clean-up before rebuilding can commence. Some areas may now even be unliveable given the shift in land and sea levels. Second, as a result of problems at nuclear power stations, the interruption to power supply may be greater and longer than was the case in 1995. Third, the loss of life this time around is likely to be much greater. This will have a potentially bigger impact on confidence than was the case in 1995. Finally, there is a risk of a serious nuclear catastrophe, which if it occurred, would result in a far more disastrous impact.”

Rebuilding Japan will be no easy task. The nation is already burdened with government debt equal to twice its yearly economic output. But analysts point out that Japan still has room to borrow, without resorting to spending down its trillion-dollar stockpile of international currency reserves. After all, last year, Japan invested $166 billion in other countries, according to IMF estimates, so it could easily redirect that money inward.

“The shock from Friday’s earthquake does not make a fiscal crisis in Japan imminent. The country’s deep and liquid government debt market will likely continue to fund government deficits, and an even larger deficit as a result of the earthquake, at an exceptionally low cost,” said Tom Byrne, senior vice-president, sovereign risk group for Moody’s Investors Service.

“However, a tipping point may be reached at some point if the market loses confidence in the soundness of government finances, and demands a risk premium on government bonds. The earthquake may have shifted such a potential tipping point a bit forward, unless Japan’s political parties are galvanised by the crisis to also address the country’s long-term fiscal challenges.”

Barring a nuclear meltdown, specialists say, in Japan specifically, but also globally, the long-term impact will be most acutely felt in the insurance industry. Initial estimates from AIR Worldwide released on March 12 place the economic loss at approximately $100 billion. Preliminary estimates of insured losses are $15 billion to $35 billion, according to both Moody’s and Fitch. And this could rise as losses are refined to include the tsunami damage, which is not yet fully incorporated in the range. These losses will fall to insurance and reinsurance companies in Japan and around the world, resulting in negative credit implications for both sectors, reported Moody’s.

That said, as we have seen with other recent natural disasters in Australia and New Zealand, construction and its materials sectors should perform well, as they benefit from reconstruction demand.

As Citi’s regional strategy analyst Markus Rosgen said on an investor call yesterday afternoon, the history of natural disasters, more often than not, provides a buying opportunity — and this time will likely be the same.

Despite the shortcomings of comparing this quake to the Kobe earthquake, because of the added nuclear issue, looking at what sectors benefited last time, might still serve as a guide for what stocks are likely to be the first to regain ground. This chart from Citi indicates what performed well in 1995.

But while this is an indicator, the big question remains power. Tepco started a rolling blackout on Monday that includes the manufacturing sector. In an effort to cool down reactor cores, they are filling the containment buildings with seawater in some nuclear power plants, which will make it difficult to resume operations. While bank analysts are hopeful that power shortages may only last until the summer, manufacturers in Japan told FinanceAsia that they are planning for power outages for a full year. If power remains spotty or, worse, there are more explosions at nuclear power plants, sector forecasts across the board will become less rosy.

What this doesn’t take into account is the human toll — and we are still very much in the early stages of this unfolding story. On Monday, people were still seeking out information about missing friends and family, with more than 10,000 people unaccounted for. As of yesterday, Google’s person finder service had nearly 140,000 records of folks leaving messages seeking information on others in Japan.

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