The devastating earthquake and tsunami that hit Japan on Friday March 11th has clearly had a huge human cost, the full extent of which will only become clear over the next few weeks.
In terms of the economic impact, we believe that there will be some short-term negative consequences, but that the longer term recovery remains in place. The inclusion of Japanese funds with the Fiducia Balanced, Growth and Adventurous portfolios was based on financial and economic fundamentals that indicated that the market appeared undervalued and was therefore attractive from an investment perspective and despite the tragic events this remains the case – perhaps even more so.
Uncertainty is always bad for investors and this is clearly reflected by the fact that the Nikkei is now down 20% (at the time of writing) since the onset of these tragic events. We believe this fall has overstated the Japanese problems. From the details we have so far the earthquake is on a much bigger scale than the 1995 Kobe Earthquake but in the less economically sensitive Tohoku region. Which accounts for around 8% of Japanese GDP, approximately half that of the Kobe area.
The area hit, around the city of Sendai, has limited contribution to the Country’s production facilities, which are concentrated in central Japan. While the current disruption to power supplies has extended further across the country, we expect this to be quickly resolved and activities outside of the area directly affected to return to normal. Japanese authorities have been quick to respond and the Bank of Japan has announced that it will add a further ¥5 trillion to its asset purchase programme and is providing ¥15 trillion (approx. $183bn) of liquidity to financial markets. It is also encouraging that despite the likelihood of a special budget to help finance the reconstruction work necessary, bond prices have remained firm. The reconstruction effort in itself may also have a positive impact on the economy.
In our view, the recovery in developed markets, most notably the US, and the ongoing growth in Asia are more significant drivers of profitability for Japanese companies. Growth in these regions is likely to remain supportive and we believe that the traditional transmission of export strength into the domestic economy will again be evident. Furthermore the typical pattern of activity in an economy after such a shock is a V-shape – a sharp fall in GDP followed by a rebound as reconstruction begins. Given the way GDP is measured, the loss of output reflects the disruption to production rather than the destruction itself. Japan is poorer as wealth has been lost, but the national income figures will only pick up the new expenditure on reconstruction. Therefore despite the significant falls we have seen in the level of the Nikkei we remain comfortable with the positions we have within the Fiducia range of portfolios. We will obviously continue to monitor developments very closely but we maintain our conviction in the undervaluation that exists within the market and more specifically within the fund’s holdings.