In this week’s bulletin:
- The terrible events in Japan have traumatised its people and global investors are assessing the financial impact
- In the short-term, Japanese stocks have fallen sharply to reflect the likely economic cost to the country – Many large exporters have shut down plants, which will hamper recovery
- Elsewhere, though investor response has been muted, most leading markets are trading little changed or flat so far
- Global markets had to contend with other issues too last week – Oil prices remained elevated as worries over Libya continued
- And the spotlight was focused on the eurozone sovereign debt problem following debt-rating downgrades for Spain and Greece
- Whilst geopolitical and other issues are impacting short-term, the longer-term outlook for global recovery looks to remain in place
- Professional investors are looking to the long-term and rarely allow short-term shocks to change their strategy. Hugh Young of Aberdeen explains his approach of ‘buy and hold’ and gives his views on the events in Japan
- Private investors should adopt a similar approach and remain focused on their longer-term aims and objectives
Wealth Management Awards: Just to let you know that the Financial Times has received an overwhelming number of votes for this year’s wealth management awards.
This means that the competition is likely to be stronger than ever.
Voting closes on Friday 18 March 2011 and, if you wish, you can vote online at www.icwealthawards.co.uk/voting.
As the catastrophic earthquake in Japan continues to take its terrible human toll, it was only a matter of time before global financial markets started to conduct their seemingly clinical audit of the likely impact of this huge natural disaster on the country’s growth prospects. In a truly global world though, the ramifications are also being assessed not just in the Far East but also in the West. Writing in The Sunday Telegraph, Fidelity fund manager Tom Stevenson succinctly explained the markets’ conclusions. The most recent parallel was the 1995 Kobe quake which incurred heavy human and economic cost: estimated at some $100bn. This time the area affected has a smaller share of GDP but the outlook is far less clear because of the added dangers of the failing nuclear plant.
Regardless, the short-term impact for the Japanese economy will be negative; in part due to physical damage but also because of the psychological trauma. The reaction from Japanese industry was swift, with the country’s three largest motor manufacturers – Toyota, Honda and Nissan – announcing they would stop production at almost all of their domestic assembly plants. The firms cited health and safety reasons as the cause. Electronics giant Sony also said it would be shutting down production. Economists warned of temporary price stagflation and economic contraction. “The timing of the disaster could not have been worse” was the view of Capital Economics, pointing to Japan’s economic contraction in the last quarter of 2010.
But whilst the immediate effects are certainly negative, in every aspect, further out Mr Stevenson took the view that rebuilding and associated expenditure would stimulate the economy. Last time around the economy followed a V-shaped performance curve, with the initial downward fall followed by a strong rebound as policy stimulus and private spending returned. The Bank of Japan was quick to promise support, saying “The bank will do its utmost, including the provision of liquidity, to ensure stability in financial markets and to secure smooth settlement of funds in the coming weeks”. Some economists are taking the view that the BoJ may well embark upon another round of quantitative easing when it next meets.
The immediate reaction of investors has been both understandable and predictable – the Japanese stock market fell sharply when it opened today, with the leading Nikkei Dow 225 Index closing down some 6%, although it had been down over 7% at one point. Again, using Kobe as guidance as to what might happen to the stock market in the slightly longer term, Tom Stevenson pointed out that the Japanese market underperformed the S&P500 for a number of months – with the latter achieving a relative outperformance of around 30%. The other aspect is the knock-on effect for overseas markets. Foreign assets tend to be liquidated first when there is an urgent need for capital and this happened in 1995 when Japanese insurance companies sold US Treasury bonds in order to meet claims by their Japanese customers. This in turn saw the yen appreciate sharply which, if repeated this time, will hit the country’s big exporters. Jim O’Neill, chairman of Goldman Sachs Asset Management said “Most of Japan’s recovery is driven by exports so the key is to make sure the yen doesn’t strengthen”.
Clearly it is too soon to be definitive about the final outcome, but in the meantime investor reaction in the Western markets has been relatively calm.
What will it mean?
The terrible events in Japan will be long-lasting but their immediate timing added further pressure to the world’s financial markets, which were already enduring a pretty torrid time last week. A toxic cocktail of bad news sent equity and commodity markets into reverse – mid-week the cost of borrowing for Portugal, Ireland and Greece hit euro-era highs amid concern in the markets that European leaders will fail to take concerted action to dispel fears of sovereign debt defaults. Attention was focused particularly on Spain following debt-rating agency Moody’s decision to downgrade the country’s rating – later in the week the agency did the same for Greece. The rise in 10-year bond yields for the so-called peripheral eurozone countries has been inexorable over the past five months as investors have taken an increasingly cynical view on any likely action to be taken on the part of policymakers. “It looks like the authorities aren’t going to do anything particularly aggressive” was the view of Deutsche Bank.
But there were tensions elsewhere too. Geopolitical concerns continued to drive the markets as Libya’s descent into civil war – and the threat of possible NATO military intervention – kept oil prices elevated. Nervous investors headed for the perceived traditional safe haven of gold, which hit a record high of $1,437 per ounce, before falling back on the week. The price of oil was little changed on the week with Brent crude closing at $115 per barrel. There was some good news for the energy sector as it was announced that other influential members of the oil cartel OPEC are joining Saudi Arabia in raising output to cool soaring prices and allay fears of a supply crunch in the West. The behind-the-scenes move by Kuwait, the United Arab Emirates and Nigeria, reflects growing unease among OPEC members over the threat to global recovery from the runaway rise in crude oil prices.
Testing Time for Global Recovery
The aspect of higher energy costs and implications was mulled over by The Financial Times. The paper opined that the level of confidence is the key outcome, following data from the University of Michigan which showed that: its index of US consumer confidence fell from 77.5 to 68.2 last month. “All the good news in the labour market has been wiped out by rising oil prices” commented Standard Chartered Bank. Developing its case, The Financial Times analysed the separate and different implications for the key players in the global economy. It took the view that the oil producers are less likely to spend all their increased revenue as it causes inflation at home so they tend to invest short term in safe areas such as US Treasury bonds. This in turn helps finance the US government but not global private consumption and spending. America itself should be able to cope quite well, according to Goldman Sachs, who estimate that a sustained $10 rise in oil prices will lower US growth by just 0.2% for each of the following two years. Current estimates for US GDP this year are a very respectable 3.5% – somewhat above its long-term trend rate of 3%.
It is the developing world that is likely to be hit hardest because overall, incomes are lower and oil makes up a far larger share of total consumption. The higher ensuing inflation could therefore cause interest rates to rise but the positive news is that government finances are in good shape and allow them to fund subsidies. UK and Europe, who are amongst the most efficient users of oil, are well-placed to withstand higher prices, although the backdrop of government austerity measures mean that consumer spending is likely to be squeezed thus potentially hurting short-term growth prospects. So the crucial question for investors is the extent to which the global economic recovery could be derailed by a combination of man-made and natural disasters.
There was some good news last week which gave an insight into the longer-term prospects for the global economy. According to the latest data, American households stepped up their spending at the country’s shopping centres and superstores last month in a sign that the recovery in the world’s largest economy is gathering momentum. Retail sales grew by 1% – the highest for four months as job prospects improved and a payroll tax boosted incomes, according to the US Commerce Department. The numbers arrived in time for the latest meeting of the US Federal Reserve which will mull over its current, ultra-loose monetary policy – some members of the Fed, such as Kansas City Fed chairman Tom Hoenig, are worried that inflationary threats are building and interest rates should rise. But US Fed chairman Ben Bernanke has remained relaxed about the risks, leaving open the option of yet more money-printing.
The economic picture is more mixed here in the UK where, unlike the US, retail sales have slowed to a crawl – up 1.1% last month compared to a 4.3% rise in January, according to British Retail Consortium data. The figures reflect that the increase in VAT and higher prices are causing fewer shopping trips. Conversely, Britain’s trade deficit experienced its sharpest monthly decline in more than 30 years in January on the back of booming exports, according to data from the Office for National Statistics. Foreign demand for British goods – including food and drink, chemicals, cars and oil – has surged as UK manufacturers capitalised on global demand. The figures will bolster hopes of an improvement in overall GDP in the first quarter of this year, following the 0.6% slide at the end of 2010.
It’s the Long-Term that Counts
Irrespective of short-term events – however traumatic – it is the longer-term that really matters. This is the view held by many leading fund managers, including top performer Hugh Young of Aberdeen, who manages Far Eastern equities. Talking to The Daily Telegraph he said “We’re not terribly good at predicting market fluctuations but we think we are good at identifying the long-term winners. We see ourselves as investors, rather than speculators. Ideally we want to hold a stock forever”. With an average holding period of nine years, he will have seen many of his holdings experience significant volatility but he has remained resolute and this is reflected in his enviable performance record.
This morning, he commented specifically on the recent tragedy. “Toyota is suspending production at all domestic factories through Wednesday. Chemical company Shin-Etsu has temporarily lost three plants. Convenience store operator Seven & I has reported about 5% of its stores are out of action. More tellingly, many companies do not know themselves how they are affected because of outages and communications failure. If there are any gainers, cynically opportunistic though that may sound, they are likely to lie among resource companies such as Rio Tinto and BHP. Japan will need thermal coal and iron ore to boost non-nuclear power alternatives. With China slowing, the demand here and for other commodities needed for reconstruction may be timely”.
As mentioned, the sharpest reaction to the latest events were, as expected, felt in Japan. Elsewhere the reaction of investors has been muted with the prices of stocks trading higher in Hong Kong and India and small falls in some of the European bourses. In London the market has, at the time of writing, reversed earlier small losses to stand up a few points. For private investors the key is to maintain, as ever, a well-diversified portfolio; by asset class, by geography and by fund manager. This approach has in the past reduced both risk and volatility, allowing clients to focus on their longer-term goals and objectives.