blocking majority

The ‘Surprises’ of the Japanese Crisis and the Investment Lessons to Learn

Success is not final, failure is not fatal: it is the courage to continue that counts – Sir Winston Churchill

The human suffering of the earthquake and following tsunami in Japan is well documented. Exceeding the magnitude of Kobe both in strength and structural damage, the final cost is unknown and the aftershock which occurred yesterday did nothing to abate the concern. Surprise consequences have revealed significant weaknesses in both the word of politics and business and from an investment point of view, there are lessons we can learn…

A Political Surprise – Germany

The ruling party in Germany was voted out of office in one of its most prosperous states after almost 58 unbroken years in power. If they lose one more state election in September, Merkel could face a “blocking majority”. Despite voter concerns over the EU rescue fund (which they see as a potential ‘bottomless pit’) and claims leaders are out of touch with business, the surprise came as instead the loss was blames on Japan. After extending the life of 17 nuclear power stations and then calling a 3 month ‘thinking period’, politicians claimed the nuclear crisis swayed voters towards a Green anti-nuclear coalition.

 

A Business Surprise – Car Makers

The other surprise came to the heads of car making companies. Reliant on tight inventory management and a high proportion of electrical components, the supply chain interruptions from suffering Japanese suppliers hit these firms hard. What surprised them the most was the fact that a lot of these electrical components came from a single source. Since these were often parts sold to previous firms to be built into other parts then sold onto car makers, this concentration risk was not identified. In reaction Peugeot, Europe’s second largest auto maker by volume was forced to slow production at 7 plants in France and Spain. Japan’s Nissan saw the affects lasting for at least a month and started importing engines from their US plants – a reversal of a trend.

 

Source: Bloomberg – Since March 11 2011, the date of the earthquake, Peugeot (white) has caught up with the MSCI Wold Index (yellow) whereas Nissan (orange) is still struggling at a 13% lower level – all performance normalised.

The ‘Crisis Effect’– Luxury Goods

In reaction to the devastation, many in Japan are spurning conspicuous spending. Tiffany lowered their earnings expectations and expects Japanese sales (a fifth of their total) to fall by 15% in Q1 against retail demand rising 11% on average across the rest of the globe. Bulgari has now re-opened all but one of their 40 stores but, as one of their biggest markets, sees sales remaining weak for at least 6 months. This 6 month figure may have been derived from a comparison with the Great Hanshin earthquake, Kobe, back in 1995 where the after-effects were felt for approximately this length of time. However, this time around there have power cuts affecting populous areas, supporting concerns this is over-optimistic.

 

Source: Bloomberg – Bulgari (orange) hardly moved post-earthquake despite earnings concerns whereas Tiffany (yellow) was hit hard (-11%) but has also staged an impressive recovery (+11%)

The Bottom Line – Heightened Uncertainty

What this all highlights is the heightened level of uncertainty we are dealing with. There remains the potential for events few of us could predict, with consequences which come as a surprise and, those that are temporary, with a hard-to-forecast end date.

 

Investment Insight: The Lessons we can Learn

There are clear lessons we can learn. With a global recovery still open to macro shocks, it is prudent to remain active with an ability to protect your portfolio, whether through managers that can reduce their net exposure to markets or otherwise. And from a more stock specific point of view, know companies in which you invest well, including the full length of their supply chain and the true resilience of their client base. It’s true that crucial, often overlooked details are often only realised during times of stress, and this is by far one of the most tragic. Never stop learning.

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Europe and a New Form of ‘Decoupling’ – How to React

The problem with international meetings is politicians are often “more interested in their next job than the next generation” – Anonymous source via Anthony Hilton, Evening Standard

Political turmoil has hit the three largest European economies in recent days. Portugal’s Prime Minister resigned, Merkel’s party was ousted from the most prosperous state in Germany after an almost 58 year uninterrupted rule and at France’s recent election, abstention reached a new high at 54% of the population. What are the main issues to be watching, how are they affecting investments and why is the term ‘decoupling’ now being used to describe countries within the EU?

Headline of Germany's biggest newspaper, Bild, 12 May 2010. Source: http://read.bi/cZa0of

Berlusconi ‘Flirting’ With Protectionism

In reaction to recent French takeovers of Italian companies, Italy is threatening to draft a bill to curtail the trend. France maintains the bill will go beyond measures conceived by Paris and tensions look to worsen as the French EDF, the largest shareholder of Italian energy company Edison prepares to replace the Italian CEO with a French counterpart.  Indeed with David Cameron concerned about maintaining an open and competitive continent, the issue is one to watch. Nevertheless, with a high savings rate and exposure to German and Emerging Market economies, the outlook for Italy remains strong. In a recent auction, the maximum amount of index-linked bonds targeted was sold on Tuesday, €6bn year to date. Domestic demand remains strong.

Spanish Growth Downgraded

Another European country with issues of its own and yet resilient market reaction is Spain. The Central Bank sees a growth outlook of 0.8% for this year, lower than the government’s expectation of 1.3% growth. Unemployment is still among the highest in Europe at ~20% and they are implementing some of the deepest austerity measures to bring their deficit inline with that of France. Nevertheless, markets are forward looking and are reacting well to the aggressive policy implementation. Spreads on Spanish bonds over the equivalent German versions continue to narrow.

Even more worrying is the 43% youth unemployment (as quoted in The Guardian), higher than both Egypt and Tunisia - leading Gregory White at The Business Insider to call Spain "The Next Egypt" http://read.bi/i7fKOu. Source of chart: Miguel Navascues, an economist who spent 30years for the Bank of Spain following a posting for the US http://bit.ly/fDGb6k

Germany Facing a ‘Blocking Majority’

After another disappointing election result, the governing party of Germany could face a ‘blocking majority’ if they lose one more state in the September elections. Inner-party opposition is looking likely to intensify and after abstaining in the UN’s vote on the ‘no fly zone’ over Libya, fears of a return to isolationism have returned. Together this could compound the indecision that has dogged Merkel’s leadership so far. Nevertheless, the country’s deficit is set to fall as low as 2.5% of GDP.

 

Equally applicable for France with their 54% abstention rate as to Germany's indecision - The once opinionated cocktail hour has gone quiet! Source: http://www.zundelsite.org/cartoons/german_party.html

A New ‘Decoupling’

Therefore, the markets are starting to differentiate between countries. Spanish and Italian equity markets are almost 9% higher than they were at the start of the year while others are still struggling.  Most interesting is the lacklustre return of Germany’s equity market despite stronger fundamentals. Although this can be explained by the idea that markets move not by information on an absolute basis but relative to past performance and most crucially – expectations. With this in mind, Italian and Spanish economies are seen to be improving and doing well versus investor-set benchmarks.

The Investment Insight

There are many more hurdles along the way. The yield on Portugal’s 5-year notes surpassed 9% for the first time since Bloomberg records began (1997). The average yield across maturities lies at 4%, but the trend is upwards and once a 6% level is reached, it is argued it will become near impossible to reduce the countries debt-to-GDP ratio. In the immediate future, today’s results of Ireland’s banking stress tests will reveal the additional capital required for adequate solvency. As always, it is wise to maintain context, exploit contagion to your benefit and focus on quality for the longer-term.