The north-east region of Japan has sustained damage estimated at around US$180bn (3.3% of GDP) with the area representing about 8% of Japan’s economy.
Japan is the world’s third largest economy, with GDP of around US$5.4 trillion, representing about 9% of the global economy. While Japan is a significant economy, it has not been a major contributor to global growth in recent years.
In 2010 the global economy grew by 4.5% of which Japan contributed only 0.16%. In the recent December quarter, Japan actually experienced a negative growth rate of -1.3% (annualised). Japan is likely to move into recession in the first two quarters of 2011, but it should start to recover in the second half, although the nuclear power plant issue adds uncertainty.
It is fair to assume that the Japanese economy will detract 0.2-0.5% from global growth in 2011. The IMF had expected the global economy to grow by 4.4% in 2011, so a Japan recession could reduce global growth to around 4.0%, which is still reasonably strong.
Initial assessment of the impact on Australia
Japan is Australia’s second largest trading partner (after China), accounting for 20% of Australian exports worth around $37bn in FY10.
Australia’s top exports to Japan are:
- Coal ($13bn)
- Iron ore ($6bn)
- Not disclosed (LNG, Nickel and Sugar) ($7.3bn)
- Beef (US$1.7bn)
- Tourism ($1.9bn) and:
- Aluminium ($1.3bn).
Japan accounts for 65% of Australian LNG exports, 40% of its coal exports and 17% of its iron ore exports. In the short term, demand for coking coal and iron ore could fall on reduced Japanese steel production, but there may be strong demand for thermal coal and LNG to offset the loss of nuclear power output.
The negative impact on coking coal and iron ore may be offset by increased steel production in China and Korea and the apparent shortage of coking coal and iron ore supply on global markets due to recent weather related events in Queensland, WA and other international regions.
The Fukushima nuclear power plant issue has escalated concerns over nuclear energy, which could be a short term and a longer term issue for uranium exports. However, there is likely to be a swing towards gas-fired energy, which will benefit Australia’s booming LNG industry.
With the Japanese fishing fleet decimated in the north-east region of Japan, there could be greater demand for Australian beef, but this is highly uncertain at this stage. Tourism will most probably suffer in the short term.
Overall, a short term negative for coking coal and iron ore exporters but may be negated by increased demand from Asia (ex-Japan), while Japan’s demand for thermal coal could actually increase.
The Fukushima nuclear power plant issue could do major damage to the nuclear power industry, in the short to medium term, but this will probably be to the benefit of thermal coal, LNG and clean energy providers. Australia would be a net beneficiary of such a trend.
Research group, Lonsec, expects the Australian economy to slow in the first quarter of 2011 due to the floods and it may remain soft into the second quarter, if exports to Japan are subdued. Thereafter, it should rebound strongly as Queensland and Japan recover and global growth continues.
If the economy remains softer than expected, the RBA is likely to keep rates on hold and may even entertain a rate cut. Lonsec expects the Australian economy to grow by 2.7% over 2011 (similar to 2010).
Initial assessment of market implications
Cash
The RBA is likely to remain on hold for most of 2011. Australian growth is likely to be negatively affected by floods and cyclone Yasi in the first quarter. Exports are likely to be negatively affected by the Japanese tsunami and earthquakes in the second quarter.
Bonds
There may be some “flight-to-safety” in the short term, as investors seek bonds over equities. However, there are some great risks in holding global bonds in the medium to long term.
Equities
The Japanese economy is likely to fall into recession in the first half of 2011.
As previously noted, the normal cycle is for a short term dip in growth, followed by a recovery. In this case, the impact of the tsunami, earthquake and the Fukushima nuclear power plant issue complicates the path to recovery. Lonsec believes it is fair to assume that the Japanese economy will detract 0.2-0.5% from global growth in 2011.
Japanese equities have fallen 16% in recent days and are obviously the most at risk in the short term. The impact on other regions is less clear and is likely to be felt on a sector by sector basis.
Likely sector impacts:
Insurance – cost of the Japanese natural disaster is estimated at US$180bn. Global reinsurers will be hit hard which will increase the cost of reinsurance for insurance companies. Hence the impact is likely to be negative for reinsurers and insurers.
Banks – there maybe increased repatriation of offshore capital by Japanese investors which could increase the cost of capital. Lonsec expects only a minimal impact on the cost of wholesale funding for Australian banks.
Mining – short term loss of Japanese steel production will reduce demand for coking coal and iron ore and a variety of base metals like Nickel. However, Chinese and Korean demand may offset somewhat and over the medium term Japanese demand should recover strongly.
Energy – there is likely to be a move away from nuclear power in the short to medium term which should benefit thermal coal, LNG and clean energy providers. Uranium and nuclear energy providers are likely to come under short to medium term pressure.
Rural – loss of part of Japan’s agricultural production may increase its demand for Australian produce, in the short term.
Industrials – only those companies exposed to the export sector are likely to be materially affected, in the short term.
The Australian market has retreated 6% in recent days. At this stage, it seems there will be downgrading in global growth prospects and that some of Australia’s exports will be affected in the short term. However, global growth prospects, in aggregate, should remain robust and Japan will recover over the medium term.
In addition, Australian companies have strong balance sheets and many sectors are now trading on less than 12x forward earnings, which is well below the long term average of 14x forward earnings. In our view, the Australian market is likely to find a base reasonably quickly, assuming the Japanese situation does not worsen considerably from here.
For more information please contact Ryan Love on 1300 856 338 or e-mail ryan.love@apexpartners.com.au.
This article is general information only and is not intended to be a recommendation. We strongly recommend you seek advice from your financial adviser as to whether this information is appropriate to your needs, financial situation and investment objectives.