The sharp sell-off in Japanese equities after the most powerful earthquake ever to hit the island nation is being viewed as a knee-jerk reaction and a buying opportunity by Asian asset managers.
Beyond contemplation of the terrible human cost of this tragedy, all are focusing on forward-looking investment implications of the March 11 quake that triggered tsunami devastation and fears over radiation leaks at domestic nuclear power plants.
Equity valuations have sunk, with both the Topix and Nikkei 225 dropping more than 16% over the past two trading days. This has created tactical investment opportunities, especially for companies and sectors set to benefit from the future reconstruction process, including materials, construction and cement producers.
Further considerations include the likely impact on commodity prices, inflation and currencies, as well as implications for international competitors, particularly companies in South Korea.
Most asset managers have been underweight on Japanese equities in terms of relative growth rates, but one global firm with a big Japan presence has been taking from cash holdings to buy stocks.
“We are in the process of adding a little bit to Japan today [Tuesday],” says its Asia-Pacific head of investment. “We have been adding opportunistically, but are still underweight.
“The fundamental outlook in Japan and corporate profits were improving [pre earthquake], while the economy had done slightly better than we expected. Now the market is down, so we think there are some opportunities in Japan.”
Certain sectors will clearly suffer as a result of this disaster, potentially benefitting Korean rivals. Toyota, for example, has shut down at least a dozen factories, and no one knows for how long.
“If you look at the won-yen cross-rates in the last two days, the won has weakened quite substantially, again a positive for Korean exporters,” notes the Asia-Pac head.
The reconstruction of parts of Japan is a potential positive for steel stocks, iron ore, coal and cement. The disaster is also likely to add to upward pressure on domestic food prices.
The Asia-Pac head notes that his firm does not own any uranium-type stocks, but that prices for companies such as Paladin and Korea Electric Power Corporation have come down substantially. “The question is, should we start looking at them now, and I think the answer is yes,” he adds, although his firm has not started to buy yet.
“Our view is that this [sell-off] is very much a knee-jerk reaction and that nuclear power will be a valid power source, particularly for emerging economies. It is something we are looking at now. These stocks have pulled back and started to become realistically priced.”
Sandeep Malhotra, CIO and head of global investment solutions for Swiss private bank Clariden Leu, notes that developed and emerging market equity markets have both rebounded over 100% from their respective lows in March 2009 and October 2008.
“So the financial markets handled the tail-risks and economies came back,” he says. “But societies might decide there are certain types of tail-risk they just don’t want to deal with, and I think the nuclear situation is one of them.
“ [Japan’s disaster] has brought forward the whole idea that risks associated with nuclear power may be higher than models suggest. The public’s acceptance of this technology will be jeopardised to the point where China and India will have to re-evaluate the [nuclear] diversification they were planning.”
A chemical engineer by training, he notes there are 442 nuclear power plants globally, with 104 in the US and 55 in Japan. China has 13 and is planning a further 27 in the next five years, while India has six and is looking to add five others.
Malhotra says a global re-evaluation on nuclear power would add upward pressure to demand for coal, natural gas and oil. “Inflation resulting from commodity prices in this case will go higher, on the energy side and also on the base metals side.
“With unrest in the Middle East and the oil situation, I think the natural response was for companies and countries to start diversifying away from oil, and now this has taken us back in the opposite direction. It is going to be all about oil and natural gas for a long time to come.”
Clariden Leu expects the yen to remain relatively strong, buoyed by a potential repatriation of assets back into Japan. Strong appreciation would likely see intervention from the Bank of Japan.
State Street Global Advisors, meanwhile, has not changed its long-term strategic view of Japan as a modest grower with an equity market that was reasonably undervalued but in need of a growth catalyst. But its short-term view has changed as a result of the crisis.
“Does the sell-off we have seen create a much better valuation picture, whereby you are now compensated for that slower growth that the market was going to give us?” ponders Dan Farley, who manages allocation strategies for SSgA’s institutional clients worldwide. “All things being equal, that is probably a true statement.
“The concern we have in the short term is we don’t really know if there is enough of a discount based on what the environment is going to be. We think there is going to be an opportunity within Japanese equities, we are just not convinced we are exactly there at this point in time.”
He says SSgA is sitting on the sidelines awaiting clarity over the nuclear situation as well as a stronger sense about the Bank of Japan’s intentions. The central bank yesterday added two cash injections amounting to ¥8 trillion ($99 billion), following on from a record ¥15 trillion on Monday.
State Street is another firm with an underweight on Japan. “So given the fact that this [sell-down] feels very knee-jerk, we have not moved to take more money out of that market, but rather we are trying to assess an opportunity to put more money back in as appropriate,” adds Farley.
He, too, suggests the longer-term implications for oil demand are positive. “About 10% of Japan’s energy production is coming out of nuclear. If that’s offline then they are going to need to replace it somehow.
“If we look at issues this has already started to have in terms of other areas of the world thinking about their nuclear programmes, these also put a bit of a bid behind oil and some alternative energy discussions. From a commodity-pricing perspective, it ends up being positive, although that might not be the case in the near term.”
SSgA is a commodity bull but has been taking profits and reducing positions. “We are not making a massive change to our position, largely because that asset class has done very well and this [earthquake disaster] does put some pressure on the global growth story,” says Farley. “The fact we are taking profits and pocketing them is still a prudent move here.”