How Will the Market React to the Quake?

Includes: CVX, FXC, PCL, SU, TMWEF
by: Market Blog

By David Berman

If you are trying to figure out how the devastating quake and tsunami in Japan are going to affect economic activity, currencies and commodity prices, you’re not alone. However, Sherry Cooper, chief economist at BMO Nesbitt Burns, has some interesting preliminary thoughts, using the 1995 Kobe earthquake as a loose template.

Japanese economy: The 1995 earthquake didn’t make a big dent in economic growth that year, with gross domestic product rising 1.8 per cent, which was in line with the average growth during that decade. Friday’s earthquake could be more damaging, though, especially to Tokyo. Ms. Cooper has cut her estimates for Japanese growth in the first quarter, but she expects that rebuilding efforts will add strongly to growth in the second and third quarters.

"Still, this tragedy could undermine Japan’s already tenuous fiscal situation, and heighten global investor concerns about public debts in Europe and the U.S., making Canada a relatively more attractive place to invest," she said in a note.

Canadian exports: In 1995, Canadian exports to Japan jumped 24 per cent, suggesting that reconstruction efforts had a positive impact. Still, exports to Japan have already been soaring: Ms. Cooper noted that while Japan has taken just 2.4 per cent of Canadian exports over the past 12 months, they have risen 33 per cent over last year (as of January). That is more than double the pace of overall export growth.

Commodity prices: Japan is the third largest consumer of commodities, behind the United States and China, and imports all of its oil. However, the earthquake could lead to lower oil demand temporarily.

"As well, a flight-to-safety will likely exert a negative impact on the prices of many commodities, which had already been under downward pressure just prior to the earthquake," she said. "Over the medium term, however, reconstruction will increase the demand for a wide range of raw materials.

Indeed, this could explain why crude oil prices fell on Friday, but energy stocks rose. Oil recently traded at $100.63 (U.S.) a barrel in New York, down $2.07. However, Chevron Corp. (NYSE:CVX) was up 0.9 per cent and Suncor Energy Inc. (SU) was up 2.1 per cent. It seems that commodity investors and equity investors are operating under different time horizons.

Meanwhile, companies that export lumber are having a good day. Plum Creek Timber Co. Inc. (NYSE:PCL) was up 2.1 per cent and Canada’s embattled TimberWest Forest Corp. was up 3 per cent.

Canadian dollar: Down. Ms. Cooper argues that Japan will repatriate funds from abroad, leading to gains in the yen.

Banks: Ms. Cooper noted that Canadian bank exposure to Japan is "negligible." The bigger concern is U.S. bank exposure, which stands at $305-billion, and European bank exposure, which totals $507-billion.