Nervous Markets Apt to Oversell on Japan News

Causeway International Value manager Sarah Ketterer comments on the Japan disaster's economic impact, the reconstruction to come, and the market's reaction so far

Jason Stipp 17 March, 2011 | 4:53PM
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Jason Stipp: I'm Jason Stipp from Morningstar. We did start to see the Japanese market recover on Wednesday, but there's still a lot of uncertainty in the area, so we're checking in today with Causeway's Sarah Ketterer--she's a portfolio manager on the Analyst Pick Causeway International Value Fund--to get some context on the situation in Japan today.

Sarah, thanks for calling in.

Sarah Ketterer: Thank you.

Stipp: The first question I have for you, Causeway released a report this week about the economic impact of the earthquake and tsunami in Japan. It does still seem like there are some uncertainty out there. As you're looking at it today, do you have concerns that there will be a lasting economic impact from the damage; things that they won't be able to recover from at this point?

Ketterer: The greatest unknown as we evaluate it is the nuclear contamination, and the news coming from Tokyo Electric Power is patchy at best, so we, like everyone else, are struggling to determine just how extensive this contamination can be. Some of it has to do with the shift in the winds and factors that are entirely out of the control of just about everyone involved, but that's the biggest unknown as far as we're concerned.

We expect power to be resumed. Now there are power shortages and rationing going on in a significant part of the Honshu area, but it's the contamination that's really the big question mark.

Stipp: So you had spoken [in the report] a bit about where the epicenter of the disaster was, and aside from the unknown about the potential contamination. What effect potentially on GDP are you seeing just from the damage that we know about, and we know certainly has already occurred? What might investors expect about the headwind on the Japanese economy that would come from that disaster, right now?

Ketterer: Well, we talk about this as a local problem--meaning it's very much confined to Japan, and this Northeast region, this Tohuku region has about six prefectures, makes up 7% of Japan's population, and about 6% of the country's total GDP.

Now a good part of the production from that area has been wiped out. But Japan is a country of excess capacity. There is a lot of supply in other parts of the country. I'd point to automotive, where some of the plants there can be literally replaced by manufacturing elsewhere in the country. It's the supply shortages that are the issue, and maybe the single most critical factor for Japan is power outages, because this is occurring across the country. Those nuclear reactors are all shut down. There were three major facilities, all shut down, that takes a good 18% to 20% of the country's power, and eliminates it.

So this is a serious problem and with this power outage, we think that could cause half a percentage point of reduction in Japan's GDP. So instead of say 1.7% real GDP growth, we're looking at something more like 1.2%.

Stipp: Sarah, you did a little bit of comparison in this report between the Kobe earthquake that happened in '90s, and what the economic impact of that was as Japan was rebuilding. As you're looking at recovery and rebuilding in Japan from this particular disaster, what impacts might you forecast, provided that some of these major unknowns are able to be stabilised?

Ketterer: We do think the response would be similar to the 1995 Kobe quake reconstruction effort, and in the case of this latest quake and tsunami, these areas that were affected were businesses in consumer electronics, semiconductors, petrochemicals, and other industrial businesses. Oil refining plants for example, all will need to be rebuilt.

So the construction industry in Japan, that has been very quiet for a number of years, should see a big tick up in business. Again, very similar to what we observed in Japan after the '95 quake.

And this should be quite positive for the economy, but it might be a good six- to 12-month lag before we see that effect.

Stipp: Sarah, I want to talk to you a little bit about the market and the market's response. So we did see the Japanese market began to recover on Wednesday, though it is still pretty far below where it was before the crisis.

We also saw some other international markets seeming to respond in a downward way to the news that was coming out of Japan. Do you have a sense of how much of the sell-off was really based on fundamentals, and how much is the market in Japan sold-off based on a fear-selling or selling because of the uncertainty, and also how much of the global markets are just selling off because of that fear and uncertainty?

Ketterer: Very difficult to quantify the answer to that question, but ... I think that today's partial recovery of the Japanese market may indicate that there was an overreaction. And investors became extremely nervous and in panic-selling they not only sold Japanese stocks, but as you rightly noted, non-Japanese stocks were also hit hard. And that's especially true of companies that might have any relation to the disaster in Japan. For example, those in the nuclear power industry, where the outlook for nuclear power from a popular perspective is rather dire.

Markets are nervous, and we've got unrest in the Middle East and severe fiscal problems in Europe--not to mention a very tentative global growth recovery. So it's no wonder that a big, absolutely enormous tragedy in Japan upset the markets.

Stipp: Sarah, I'd like to speak with you a little bit to close on your portfolio. So you folks are certainly fundamental investors, and I know that you know your holdings very well. You do have a stake in Japan, around 20% or so as of our most recent data.

As you are accessing the impact on your portfolio holdings, were there any particular areas of concern? And on the flip side, do you see that there were any opportunities there to maybe add to some positions that might have been sold off indiscriminately?

Ketterer: Yes, and very much so. We have about 12 Japanese holdings. Companies who are listed in Japan but may do a preponderance of their earnings outside of Japan, and some of whom are quite indigenous in how they generate their sales and earnings.

Some of the most interesting candidates are companies like JGC, a world-class engineering firm that designs and constructs plant facilities for the energy sector. What we are expecting, although the stock sold off heavily in the first couple of days post-quake and tsunami, is that the company will end up with a massive post-quake rebuilding and reconstruction effort, much of that will fall into their lap. But they do only 15% of their sales in Japan. The rest is all in developing countries. So they are not really a Japanese company, but their stock price was hit very hard; and interestingly, it rebounded 17% today, which gives you an idea of how much irrationality is coursing through markets.

Perhaps, one of the most interesting buys currently that hasn't had a big rebound--that the market has yet to understand how little it was affected--is Honda Motors, one of the world's most profitable automotive manufacturing companies. They have a very large overseas manufacturing base, and only 11% of their overseas sales are met by Japanese base production. So even though power blackouts and supply shortages may affect them, we think Honda has been far oversold, and its upside is easily in the 20%-25% range.

Stipp: Sarah Ketterer of Causeway International Value, thanks so much for calling in today and for your insights on the situation in Japan.

Ketterer: Thank you.

Stipp: From Morningstar, I am Jason Stipp. Thanks for watching.

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Jason Stipp  is Editor of, the sister site of

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