Money Morning Chief Investment Strategist Keith Fitz-Gerald has spent almost every summer for the past two decades at his family home in Kyoto - which is why he knows Japan in a way that few other U.S. traders could ever hope to.
As part of Money Morning's continued coverage of the disaster in Japan, Fitz-Gerald is sharing those insights with readers. Here are the highlights of a question-and-answer session we held with Fitz-Gerald late Thursday).
Money Morning (Q): Keith, with all the concerns about government-debt defaults in Europe, uprisings in the Middle East, and the emerging "deadbeat states" crisis here in the United States, there was already enough "bad news" to inspire considerable worry about the ongoing global recovery. And then comes along the earthquake, tsunami and nuclear disaster in Japan. Just from an economic standpoint - and by no means are we forgetting about the tragic side of this - how much will the quake impact the world's economy?
Keith Fitz-Gerald: Despite the fact that Japan's economy is the third-largest (following the United States and China), it hasn't been a global-economy driver for years. To give you an idea, consider the fact that Japan represented about 18% of the world's gross domestic product (GDP) as recently as 1995. As of 2010, that had fallen to only 9%. Initially, I think that translates into a drop of just 0.1% to 0.3% in the global- growth estimates of 4% for 2011. Longer- term, however, this crisis appears to be worsening by the minute. I am particularly worried about all the stimulus that is going to be required to absorb the shock in many countries - not just Japan. I think the world's central bankers have been tremendously misguided and overly optimistic about their stimulus initiatives. What's more, global-growth expectations may not be a solid as everybody thinks.
(Q): This earthquake is so much worse than the Kobe earthquake (also known as the Great Hanshin earthquake) of 1995. With the current disaster in Japan, how will the country's industrial base cope?
Fitz-Gerald: The specifics remain to be seen. But remember this: Japan has dealt with earthquakes for thousands of years; its culture is prepared - as no other in the world - to cope with this on a variety of levels. To put things into context, the area affected by the earthquake and subsequent tsunami is about half of the geographic area affected by the 1995 Kobe quake. People thought it would take a decade or more to bounce back from that disaster... yet four out of five shops were open again a mere 18 months after the quake. What stands in stark contrast, though, is that the devastation this time around is much more concentrated. And with the nuclear threat now looming, this situation is potentially a whole lot worse.
(Q): Will this affect U.S. exports? And if it does, how big will that effect be?
Fitz-Gerald: It's too early to tell. Japan accounts for about 10% of U.S. exports and rebuilding efforts will likely require fresh materials in all sectors. So there may actually be an uptick in U.S. exports to Japan into 2012.
(Q): What about the stuff we buy from Japan?
Fitz-Gerald: Roughly 30% of what we purchase from Japan consists of cars and car parts, so if there's an impact it's likely to be felt most strongly in the auto sector. Right now, Toyota Motor Corp. (NYSE:TM), Nissan Motor Co. (OTCPK:NSANY) and Honda Motor Co. Ltd. (NYSE:HMC) have more than 20 factories and sub-factories that are shut down. Those shutdowns were ordered, in part, to assess damage while part of that is the result of rolling power outages that may potentially affect Japanese production for months.
(Q): What about the nukes?
Fitz-Gerald: If there's a game-changer, this is obviously it. The information I am getting suggests that the situation is far more dangerous than the Japanese government is letting on. If this is true, then that government is following the same tired script, which includes ‘maintaining face' - instead of focusing on the correct objectives, such as maximizing public safety and maintaining financial surety. The same can be said of Tokyo Electric Power Co. (OTCPK:TKECY), or TEPCO (which has a long history of providing incomplete, misleading and falsified records, including those related to earlier nuclear leaks that date all the way back to the early 1980s). I hope I am wrong. But I think that it's significant that the U.S. embassy has warned U.S. nationals who are situated within 50 miles of the troubled power plant to evacuate, and that the embassy is now laying in flights to get people out. The EU International Atomic Energy Agency director has expressed similar concerns. Tokyo is only 125 miles away, which makes this a true nightmare in the making.
(Q): Speaking from a purely financial standpoint ... and not ignoring the human toll in any way ... what business sectors - and what types of companies - figure to be affected by this growing disaster, and in what way?
Fitz-Gerald: As you say, speaking from a purely financial standpoint, I see some very specific effects. Steel, coal and alternative-energy companies are likely to benefit from the massive reconstruction spending. The same is true of oil, diesel and heavy-equipment makers. Ironically, because of the production problems I just mentioned, U.S. auto parts makers can step in to fill any production gaps. In Asia, I'm expecting short-term memory-chip shortages; Japan provides a huge number of short-term memory chips for such high-volume products as wireless phones and Apple Inc. (NASDAQ:AAPL) iPads. Already, Chinese companies are seeking alternative suppliers. Producers from both South Korea and Taiwan may step in to fill the gap.
(Q): Could it get any worse?
Fitz-Gerald: Unfortunately, yes. Mt Fuji - the large snow-capped mountain typically associated with Japan in tourist brochures and news footage - is experiencing tremblers. The most recent was a 6.0-magnitude quake on its slopes in the Shizuoka area. Fujiyama, or Fuji-san as it's known to the Japanese, is a volcano that's been dormant for 300 years, and that's widely considered overdue for an eruption. And experts note that earthquakes have triggered such activity in Japan's past. Should this happen now, the human toll would be beyond comprehension. And it would likely send markets worldwide into complete panic. Despite the selling pressure of the past few days, this is something we haven't seen, yet.
(Q): Japanese debt could top a quadrillion yen. Is Japan bankrupt?
Fitz-Gerald: Yes, but in the same way our country is "bankrupt." As long as the central bankers can maintain the illusion that they are in control with their injections and other fiscal chicanery, the economy can function. But once people realize just how bad this actually is and what a house of cards they've built, I believe Japan 's bankruptcy is all but certain. It's worth noting, though, that this may take years and that the more than $200 billion in recovery spending now being contemplated will push the financial day of reckoning farther into the future. It's hard to imagine, but Japan could turn into a modern-day Argentina if it has to default the way that nation did decades ago. As you know, I feel the same way about the United States, which continues to engage in well- intentioned - though thoroughly misguided - fiscal folly.
(Q): The Japanese markets rebounded strongly yesterday (Wednesday). What's your take?
Fitz-Gerald: I think this is premature. Having missed the boat on the historic rebound that U.S. stocks have enjoyed from the March 9, 2009 bear-market lows caused by the global financial crisis, many investors see this as a proverbial "second chance." So they're going bargain hunting and making contrarian plays of their own. I think they're more likely to be catching falling knives. I expect Japanese stocks to lose about 25% of their value in the next six months as earnings revisions based on current production shutdowns, the nuclear impact and reconstruction are factored in . Remember, Japan was struggling before the earthquake and tsunami to produce even 1% growth. Now - and literally overnight - the projections have gone from 1% growth to a 4% contraction. That's a 5% swing that will take markets months to digest. And the additional negative sentiment that results from the string of earnings downgrades that we can expect in the months ahead will serve to reinforce the uncertainty that's grown out of the current disaster.
(Q): What about our own markets?
Fitz-Gerald: I'm expecting a bounce in the next day or two. It's worth noting that more than 50% of stocks have reached 20-day lows, which suggests (technically speaking) the potential for a bounce. However, with a situation that's threatening to spiral out of control - as this one is - I think that any such move on the part of investors would be premature. In fact, absent a move by Japan 's leaders to provide that country and the rest of the world with a candid and truthful assessment of the state of the nuclear-power plant problem there, traders will probably continue to head for the sidelines. And they'll stay there until we all have a better understanding of what's actually happening in Japan. If you're an investor - no matter where you live, or what markets you trade - the best advice I can give you is to maintain perspective and mind your "protective stops."