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The Japanese earthquake and its global impact

As events in Japan continue to evolve, the world waits for the full extent of the human, physical and financial destruction to become clear. Last week’s earthquake was the largest in over 100 years, measuring 9.0 on the Richter scale and triggering a tsunami which ravaged large areas of the north-east coastline – an area that accounts for 6 to 7% of Japan’s GDP. The markets reacted swiftly; investors sold off Japanese equities in response to fear of the unknown and the Nikkei 225 Index fell by 15% in a six day period. The Bank of Japan responded aggressively, injecting large amounts of money into the economy - to boost liquidity and to protect a fragile economy from collapse. At the time of writing, this amount is more than half a trillion dollars.

Behavioural finance research into investment psychology indicates that markets often react sharply to natural disasters and that these reactions can be too fast and easily reversible, which could mean bad news for an investment portfolio. An initial investment response to Japanese events from Barclays Wealth encouraged clients to avoid “selling at the bottom of what turns out to be a short-lived setback, or perhaps buying at the top of a short-lived spike¹.  Indeed, Barclays Wealth’s view on Japanese equities is that they remain attractive and should continue to comprise up to 15% of a developed equities investment portfolio over the medium term.

There is sound reasoning behind this view. It is important to remember that Japan is a resilient nation, has experienced similar events in the past and has demonstrated an amazing ability to recover from them. Cast your mind back to the January 1995 Kobe earthquake, which caused devastating human cost, pushed the Nikkei 225 Index and Japanese equities to plummet and consequently triggered a surge in the Yen. However, as Barclays Wealth observes, these market and currency movements were reversed within the same year.

One Financial Times journalist, living in Tokyo, observed recently that in the current instance, “notwithstanding the cost in lives and disruption, the economic impact on a country as wealthy as Japan is likely to be minimal"². However, this time, things are markedly different. Japan is suffering a three-pronged attack; earthquake, tsunami and nuclear threat. The explosions at the Fukushima nuclear power plant have threatened to elevate Japan’s problems to a new level, one which did not exist in 1995. The potential for more lasting impact is as yet unclear.

There is already discussion around the long-term viability of nuclear energy - is the risk of something going wrong too great? What does this mean for renewable energy sources? Oil and gas? Coal? One thing is for certain; if Japan is able to control and contain the nuclear threat they face, that will be good news for the Japanese economy, Japanese equities and the global stock markets.

The comment issued earlier this week by Barclays Wealth encouraged investors to remain overweight in developed equities as part of a balanced long-term investment portfolio. The message is: do not panic and keep faith that Japan will recover from this natural disaster. Japan is a grown-up nation, we are in grown-up markets and it is important not to react too harshly. One closing comment from the Financial Times: “the greatest cause for optimism about Japan is the reservoir of social capital that has sustained it through two tough decades"³.

Once the dust has settled and the full extent of the impact is visible, Japan will rebuild. Such is the anticipated determination of the Japanese people to recover from the disaster; the question on the rebuilding programme will not be “how is it funded”, rather “by how much will it be funded”.  The standard constraints on Japanese public funding typically do not apply in an emergency and there is already confidence that fiscal support will ensure that rebuilding progresses.

Individuals interested in investment exposure to Japanese equities specifically, may want to consider Exchange Traded Funds (ETFs), such as the iShares MSCI Japan or managed funds, such as Neptune’s Japan Opportunities or Invesco Perpetual’s Japan fund.

The value of investments in ETFs and managed funds can go down as well as up and you may receive back less than you originally invested.

¹Initial Investment Response to the Events in Japan, Barclays Wealth, March 2011

²Japan is rich in resilience”, Financial Times, 11 March 2011

³Japan is rich in resilience”, Financial Times, 11 March 2011