Likely trends from the Japan crisis and what's driving them for stocks, indexes, forex, commodities both in spot and binary options markets:
I've spent the better part of 2 days trying to grasp the full scope and market ramifications of the crisis in Northeast Japan that has dominated the attention of all financial markets this week, despite significant developments in the EU debt crisis and MENA uprisings - both of which similarly dominated markets in past weeks. The following is a summary of what's happened, what's likely to drive further sentiment on the crisis, and likely trends. We include plentiful links to further resources for those wishing to examine aspects of the below in greater detail.
On Friday March 11 around 07:01 GMT, an 8.9 magnitude earthquake hit off Japan's northeastern coast. The resulting tsunamis and aftershocks left over 10,000 dead and well over 4 million buildings and homes without power as nearly a dozen nuclear power plants were shut down. By 12:03 noon GMT officials declared a nuclear emergency at two power plants near Tokyo. Initially, market reactions were muted as this was seen as a local problem with relatively minor and short term effects.
Over the coming days, however, it became clear that crippled reactor cooling systems meant a growing threat of a massive radiation leak of Chernobyl-like proportions as reactors melted down and spent fuel rod pools boiled off water and threatened to catch fire and send clouds of radioactive material into the region.
As of this writing there have not been any fuel rod fires or widespread radiation leaks, and authorities claim that power will soon be restored to the cooling pumps needed to prevent that. Whether Japan avoids a catastrophic radiation release depends on whether Japan succeeds in restoring cool water recirculation into the spend rod storage pools.
Two Primary Drivers of Sentiment About Japan
Initial estimates of the total direct damage to Japan's economy from the quakes, tsunami, and nuclear power plant failure vary. Reuters reported it at around $200 billion. BNP reported GDP could drop 13% in the coming months, and an overall 3% blow to growth in 2011.
Currently there are just too many uncertainties (duration of rolling power blackouts, supply chain disruptions, etc) to give a reliable final cost estimate.
What we do know is the two factors that will drive market outlook on the damage to Japan. We won't have a clear picture of the ramifications of the crisis until:
1. The expected aftershocks finish and final earthquake/tsunami damage is assessed. This story is not finished. Per one report, in the case of an 8.9 quake, the odds are there will be one aftershock of more than eight on the scale and 10 of more than seven. So far we have only had one that has been more than a seven. Meanwhile, aftershocks are moving toward Tokyo.
The quakes so far have weakened buildings far, far from Sendai, including in Tokyo, making them vulnerable to more shocks. In effect, there may be several major quakes ahead that will be hitting installations that are already now prone to collapse or malfunction.
2. The threat of additional radiation leaks has passed. The possibility of vast uninhabitable areas and ~$200 billion clean up costs like Chernobyl's may be remote but they're scaring markets silly.
Both of the above remain vast wildcards at this time, though the drama that is moving markets is the threat that radiation leakage could metastasize into a catastrophe on the scale of the Chernobyl disaster.
Indeed on Wednesday March 16, the Dow Jones Industrials seemed to move in lock step with news on each new update on the Fukushima situation. See here for illustrated chart.
Currently, on the International Nuclear and Radiological Event Scale (0-7) the Fukushima incident appears to be a level 5, like the 1979 Three Mile Island incident. The cleanup cost for that was around US $975 million and took 14 years to complete. Chernobyl was a level 7—the only one so far.
Spent Fuel Rods the Prime Radiation Threat?
For full details see here. Key points include:
- The potential radiation in the spent fuel pools is said to be between 20-50 million curies.
For perspective, the worst nuclear accident ever, the 1986 Chernobyl meltdown, released about 40% of the reactor's 6 million curies. That was enough to render the surrounding areas uninhabitable, sent radiation clouds over hundreds of miles reaching as far as Sweden.
The total cost of resettling inhabitants, cleaning and sealing the area and paying off medical claims is estimated to be around $235 billion - with another billion or two added to replace the decaying sarcophagus that envelopes the reactor core and prevents new releases of radiation.
That's considerably more than the currently estimated TMI incident level of under $1 billion.
Damage to Exports
So far we've only estimates of losses to certain high profile firms. For example Goldman Sachs estimated hits to major automakers as follows:
- Toyota (TM): a $73.3 million profit reduction/ day due to production losses (via MarketWatch).
- Nissan(NSANY.PK): a loss of $24.7 million a day from plant closings
- Honda (HMC): losing $24.7 million a day; production is halted until March 20
There are also other production related losses, for example, those from fleeing expats. They aren't a large part of the workforce but they tend to hold senior posts and their prolonged absence could hurt operations.
Again, until the threats of both spreading radioactivity and the potentially strong aftershocks have passed, we can't begin to assess real losses from damage and medical costs, lost productivity from power and other infrastructure shutdowns, and so on.
Fiscal Damage and Impact on the Yen and JGBs
In the short term, there's been no negative affect on the JPY or Japanese Government bonds (JGBs). If anything, they've outperformed, with the USD/JPY hitting new lows as the Yen rose on anticipated demand from tax advantaged profit repatriation from exporters similar to that which was permitted in the wake of the 1995 Kobe quake.
Longer term, the affects should be negative.
The combined loss of GDP and need for additional spending for rebuilding means that Japan's roughly 200% debt to GDP ratio, the highest in the developed world, is headed higher. The long term picture for the Yen and JGBs are well known to be terrible. The domestic demand for JGBs, which has kept rates low, is shrinking as the population of savers ages and cashes in these bonds to fund retirements. That ultimately means rising rates, a problem for a nation where debt service is already over 25% of the budget with 10 year bonds yielding only about 1%. A rise to 2% would still be low by international standards, but would put debt service at over half the entire Japanese budget.
The big question: What happens if Japanese retail investors hurt by the quake need to sell their bonds in quantity, causing a drop in demand, and a spike in yields? Will this accelerate the day of reckoning?
Conclusion: More Downside for Nikkei, Japanese Exporters, and the JPY
Yes, these should see more bounces higher after the week's dramatic selloff, but until we have clarity and aftershock and radiation threats pass, there is more downside risk ahead - and that's before we even consider the still very much alive crises in the MENA region and Euro-zone. At least until QE 3 becomes official.
We remain short the Nikkei and its prime exporter components like Toyota (TM) and other major stock indexes in the coming weeks.
We wait for the JPY to top before entering JPY shorts as the repatriation affect ends and markets begin to consider the longer term affects of added liquidity and deficit spending on the JPY.
Impact On Forex
As noted above, the JPY is getting what is likely a short term boost, though the longer term implications for the JPY are all negative as money printing and deficit spending just get worse.
Beyond that, the impact of the crisis has been fairly typical for a major 'risk-off' event. It has boosted to safe-haven currencies like the JPY, USD, and CHF, and pressured safe havens.
The big exception has been the resilience in the EUR rally. No immediate fundamental explanation. Joel Kruger of dailyfx suggested that the EUR's continued ability to resist major pullbacks suggests that there are big buyers out there looking to diversify out of the USD on any EUR dips. That's as good an explanation as any.
Ramifications for Nuclear Related and Fossil Fuel Assets
Short-to-medium-term we're bearish for anything related to nuclear power like:
Short-to-medium-term we're bullish for fossil and alternative fuels and builders of related infrastructure. Natural gas and coal suppliers, as well as builders of plants fired by these fuels like Calpine (CPN) are expected to be winners.
Longer-term nuclear related assets will likely be back strong as the world again realizes it has no other viable cost effective alternative to fossil fuels, and $150+/bbl oil causes nations to reconsider nuclear power. That makes such stocks as France's nuke plant builder Areva (ARVCF.PK) attractive once sentiment stabilizes.
Ultimately that means still higher prices for fossil fuels, regardless of MENA developments, and a likely comeback for the above nuclear stocks.
Bullish For Currency Hedge and Hard Assets
The crisis in Japan, the third in the past 4 weeks to grip markets' attention (remember MENA unrest and the EU debt crisis?), combine to create more of an argument for delayed tightening in the EU and for QE3 in the U.S., that continues to favor gold, silver, and other hard assets that serve as currency hedges for the JPY, USD, and EUR.
Impact on Other Countries: Mostly Indirect Via Market Sentiment, Supply Chains, etc.
The U.S.: Little Direct Affect, Major Indirect Influence
It's bearish for some U.S. companies with heavy Japan exposure. See here for details of the U.S. firms with the highest percentage of total sales in Japan.
Only about 1.5% of S&P 500 firms' revenues come from Japan. See here for details
Note however, that as we've seen in the past week, the crisis can have a decisive impact on the index via its influence on overall market sentiment. Also, it's unclear what other indirect affects Japan will have on the US. For example, Japan is a major supplier of steel, silicon wafers, and other key materials and thus slowdowns or stoppages will affect supply chains In the U.S. and worldwide. See here for details.
China: Energy Exports To Benefit, Steel and Aluminum Importers To Suffer
Per a Morgan Stanley report, in 2010:
- 36% of China's coal exports and 21% of crude petroleum oil exports went to Japan. Overall Japan consumed 8% of Chinese exports, and if anything, that figure will increase as Japan becomes more dependent on imported fossil fuels.
- 44% of China's steel product imports and 27% of aluminum product imports were from Japan. Thus as with the US and other nations, China may suffer some supply chain issues for some of its heavy industry.
The EU: Same As above
Most of Japan's impact on the EU will be via how events in Japan influence risk appetite and supply chain issues.
Until the threats of both aftershocks and radiation pass, expect markets to chop-up on quiet or good news days, down on bad ones. Don't forget the EU and MENA crises, which dominated markets in prior weeks. We now have three major regions in turmoil (never mind U.S., Chinese, and Korean issues just waiting to heat up), so markets are nervous. At least until QE3 becomes official, that is.
Disclosure & Disclaimer: The author is short EUR. No other positions. The above is for informational purposes only and not to be construed as specific trading advice. Responsibility for trade decisions is solely with the reader.