World in better shape to weather Japan disaster
Updated: 2011-03-25 06:26
(HK Edition)
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The world is in a better shape to weather the crisis in Japan as it comes at a time when the global economy is in the mid-cycle of a large-scale business recovery.
This recovery has been under way since the collapse of Lehman Brothers in 2008. The Lehman crisis hit at the end of a business cycle; so the element of timing is very important. Being in a mid-cycle means that the economy is stronger and better positioned to withstand the effects of a crisis.
When the Lehman crisis occurred in 2008, corporate balance sheets were being re-leveraged, profit margins were being squeezed, and the profit cycle was in decline. It is a very different situation now. Free cash flow is at record levels. We are recapturing previous profit peaks. Cash on balance sheets at corporate publicly traded companies is at a high not seen since 1955.
Another consideration is the effect the Japanese crisis will have on world liquidity. The Bank of Japan has taken and will likely take more steps to add liquidity to the economy in an effort to keep banks and financial markets functioning. To do so, it will have to bring capital back to the country. I believe this is the appropriate move for the bank to be making.
US Federal Reserve Board Chairman Ben Bernanke has said that the two biggest mistakes made by central bankers in the last century involved not providing enough liquidity to a system in crisis. That happened in the aftermath of the Great Depression in the 1930s and the Japanese economic and banking crisis of the 1980s and 1990s.
Bernanke's thesis was that central bankers had been too timid. So, at this point in time, it is likely that the Fed will join with the Bank of Japan to provide easier money for a longer period. The bottom line is that this means interest rates will likely stay lower for longer.
The economic effect on the US is limited. However, the crisis is likely to depress growth in Japan, which is the world's third-largest economy, in the short term. However, I don't expect the US economy will be significantly affected. In general, the US economy is only slightly dependent on exports, which make up from about 8 percent to 10 percent of its GDP. Only a small percentage of these exports go to Japan, and most of the US trade is with Japan's southern islands, not the northeastern region, which was the hardest hit by the quake and resultant tsunami. So, I would not expect there to be any direct impact on US GDP or on the corporate profits cycle currently under way.
I would also point out that there is likely to be a lot of spending on capital infrastructure in the aftermath of the crisis. Several American large-cap companies are poised to benefit from this spending. China, South Korea, and Brazil are also very well positioned to benefit because they can export basic materials to be used to rebuild Japanese cities. With this in mind, I want to emphasize that I do not believe the crisis in Japan has derailed or will derail the business or profit cycle that we are experiencing worldwide.
In the short run, the crisis in Japan will depress economic activity in the country, but in the long run it will likely be stimulative. I expect the Japanese economy will grow faster than it otherwise would have as the country rebuilds.
Many sectors, such as commodities, late cyclicals, and energy stocks, are likely to experience longer-term benefits because Japan will have to shift some of its electric generation power back to fossil-based fuels.
This switch to fossil-based fuels is likely to push energy and commodity prices up in the long run. In the short run, there has been a demand disruption in Japan. This disruption, which has caused oil prices to fall, has given the US consumer some temporary relief in terms of gas prices. As I have been saying, gasoline prices at the $4 per gallon level were threatening to put the brakes on the US economic recovery. Lower prices, therefore, should give the US recovery a chance to find its legs, and in the end, help make it more sustainable.
The author is chief investment strategist at MFS, a global asset management firm. The opinions expressed here are entirely his own.
(HK Edition 03/25/2011 page2)