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With a magnitude of 9.0, the March 11 earthquake in Japan was the worst in that country's 300-year history and was the fifth-worst the world has ever seen.
That trembler, coupled with the devastating tsunami that followed, ignited a flurry of fears and caused a two-day sell-off that sent Japanese stocks down 17%. The sell-off wiped out more than $650 billion in shareholder wealth.
Keynesians, with whom I normally disagree, said the required reconstruction work would be financially beneficial for Japan.
From an economic standpoint, that's total nonsense: It contradicts the "Bastiat broken windows paradox," as I will explain. But for investors, Keynes might as well have been right – meaning the Japanese stock market is actually quite attractive.
Why Japan is a "Buy"
The French free-market economist Frederic Bastiat (1801-50) predated John Maynard Keynes (1883-1946) by almost 100 years, yet he had elegant disproof of one of Keynes' central contentions – that public spending, no matter how useless, helped an economy.
Bastiat postulated a village in which there were unemployed glaziers. Those glaziers could be put to employment if they employed the local youths to break all the village's windows. The glaziers would then get work.
If we consider Keynes' theory, the glaziers would be richer. But Bastiat would tell us that, in reality, window-breaking would impoverish the non-glazier villagers, who would be forced to pay for window repairs instead of buying other things that they wanted or needed (which would create jobs elsewhere) or saving the money (which would increase the village's stock of capital, improving its living standards in future years).
In short, the village would be impoverished – not enriched – by the window breaking.
The same is true in Japan, where the earthquake's damage has made the country poorer, not richer. This is obvious to ordinary people, but not, apparently to economists or to several bank analysts, who have produced pieces rejoicing on the additional gross domestic product (GDP) that would be created.
That's a true statement, as far as it goes: Additional GDP would be created by the construction work, but that's a flaw in the GDP statistic, which does not recognize the negative output produced by the earthquake's damage.
On the economic argument, I have to say that Bastiat is the victor.
When we talk about investors, however, Keynes might also be right.
You see, the list of those hurt financially by the earthquake include the Japanese government (so don't buy Japan's government bonds), insurance companies (who will make up their losses through higher future premiums) and the unfortunate Japanese people themselves. The financial beneficiaries, on the other hand, will be construction companies (mostly quoted on the Tokyo Stock Exchange), and housing companies (ditto) together with capital equipment manufacturers (ditto II.)
Of course, even among listed companies, there will be some losers. Tokyo Electric Power Co. (PINK ADR: TKECY), or TEPCO, the unfortunate owner of the damaged Fukushima Daiichi nuclear power station, will lose a functional power plant that may not have been fully insured, and will suffer endless clean-up costs and compensation claims. Clearly not a "Buy."
Then there are Bastiat's "losers," particularly the manufacturers of luxury goods, which will not sell as much in Japan because consumers will have to spend money on rebuilding. Apple Inc. (Nasdaq: AAPL) has postponed the March 25 launch of the iPad 2 in Japan, while stocks in the likes of LVMH Moet Hennessy Louis Vuitton SA (PINK ADR: LVMUY) and Hermes International SA (PINK: HESAF) have been badly hit.
In any case, most of Japan's equity value is in the big exporters, such as Toyota Motor Corp. (NYSE ADR: TM) and Sony Corp. (NYSE ADR: SNE). These companies have been forced to close factories and other operations for a few days. But their international sales have been unaffected and they should be able to make up production quickly – from factories outside Japan, if necessary.
The only proviso here is that the Bank of Japan (BOJ) must prevent the Japanese yen from rising too far (which is what the currency did following the Kobe earthquake in 1995) since a super-strong yen would choke off exporter profitability.
Immediately after last Friday's earthquake, however, the BOJ immediately bought another $180 billion of bonds in its own "quantitative-easing" move, so it looks like it got the message from the export community.
That brings us to the stock market itself.
Four Firms That Figure to Gain
Since achieving its post-financial-crisis bear-market lows in March 2009, the U.S. Standard & Poor's 500 Index is up 86%. Japan's Nikkei 225 Index is up only 27% during the same period. The S&P is currently trading at about 16 times earnings, while the Nikkei is carrying a Price/Earnings (P/E) ratio of 14.2.
Clearly, there's room for growth in select Japanese stocks.
To play the Japanese market overall, there's the iShares MSCI Japan ETF (NYSE: EWJ). Among the exporters, Toyota Motor Corp. (NYSE ADR: TM) and Sony Corp. (NYSE ADR: SNE) will do fine.
Kubota Corp. (NYSE ADR: KUB) is a major Japanese maker of construction equipment, pipe-related products and components for water and other environmental systems – all things that figure to be in big demand.
Finally, you should look at Daiwa House Industry Co. Ltd. (Pink Sheets ADR: DWAHY), one of Japanese largest housing manufacturers. Like Kubota, Daiwa House has a product that figures to experience a lot of demand.
Bastiat was right, economically; but if we ignore him, we can see why Japan is a "Buy."
But here's the problem: Only 1% of investors know about it.
Fortunately, Money Morning Contributing Editor Martin Hutchinson is among that 1%. The 37 years he spent as an international merchant banker gave him that knowledge, and that insight.
Now you can access that insight.
With Hutchinson's The Merchant Banker Alert advisory service, you can crack this "rich-man's market," discover the identities of those stocks – and reap those massive gains yourself.
Click here for a report that shows you how to get started.]
News and Related Story Links:
- Money Morning "The Japan Disaster" Series:
Japan Update: How to Proceed in the Wake of Japan's Tragedy. - News Archive:
Stories About Quantitative Easing. - University of Washington Soil Liquefaction Website:
The 1995 Kobe Earthquake. - Wikipedia:
Glaziers. - Wikipedia:
Bastiat Broken Window Parable. - SmartMoney.com:
Lessons From the Kobe Earthquake. - Merchant Banker's Alert Special Report:
How to Crack the Rich Man's Market.
What about cement companies that will benefit from the rebuilding in Japan? It seems so trivial that we should worry about these things when there is so much suffering in Japan but in the end the money we put into these companies may in some way help. Thanks, Joy
I'm not so sure that Bastiat and Keynesian economists were talking about the same thing. The Keynesian idea is that there are times when people hoard money (because of pessimism about economic prospects), and this leads to unemployment which gives rise to a host of social problems, and (in the long term) possible declining production capacity. Hence, were the government to borrow money in those times to hire the unemployed people, it could reduce those social problems and possibly even turn the tide of pessimism. This is not an argument that if the projects are misspent then wealth will be increased. However, it's reasonable that the social ill of unemployment might still be lowered in such a case, and that in the long term, preserving the social order and production infrastructure are preferable to a cycle of irrational fear, money hoarding, and eventual atrophy of productive resources.
Bastiat is talking about overall wealth, and his example is assuming that the money not spent on the broken window would be spent elsewhere. Note that Keynesian "stimulus" presumes that there is a problem of money hoarding and "pessimism," which are not even an issue in Bastiat's story. Of course there are people who abuse Keynes to support stupid projects and excess borrowing in both good times and bad. But nothing in Bastiat's argument disproves the idea that increased government spending during a recession may help to turn the economic tide and prevent a downward cycle.
Marin,
Dude, an earthquake is a "temblor" not a trembler. Yeah I know. It doesn't make sense, but there it is. Fitz-Gerald did the same thing in his column. No big deal, but I thought you might wanna know.
keep up the goodwork!
Thank you for the editor's summation of the catastrophic events in our world. The overview
gives a sense of where one needs to go next.
Like a phoenix rising, I would very much like to join the advisory service of Mr. Martin Hutchinson's "Merchant's Banker's Alert". To gain wealth, one has to plan. To plan, one needs information. I like Mr. Hutchinson's well based and princilpled approach. I feel confident that implementing his recommendations would help achieve that end. But I run into a dilemna when a lot of monies earmarked for investments end up defraying the costs of subscriptions for which I have 2-3 of them. I understand that some capital is needed to get to this end goal. Do you have any method of accessing these reports in a more affordable fashion so as not to lose more time trying to save up for the cost of these reports? Do you have a way for me? Thank you very much. Best regards. M. Martin.
Martin,
Thank you very much for your insightful view on Japan. As one of the natives here, it has not been a very good feeling to see 'bad news' on this country.
I know it is somewhat too late to comment on this article, but I would like to add one comment here from an insider's perspective.
I was born and raised here until high school and went on to go to university in the US. Together with my working experience during the economic bubble in 1980's in the US, I lived there for about 10 years. So as native Japanese I experienced both economies, especially lost 10 or 20 years of post era after bubble burst in 1990. I can tell you that it is not a pleasant experience to go through the earthquake even in Tokyo on March 11. (A huge bookshelf almost fell on me.) I had to walk back home for four hours at late cold night as no subways or public transportation were working. I did not know exactly what happened right after the earthquake. But it was more than sad to find out all the news stories on TV what happened and continued to develop.
As you know all kinds of aids and help were coming to Japan to those who suffered up in the northeastern part of Japan. We all are very much appreciative about what people in the world are reaching out to do.
Please let me add from our perspective. I can certainly tell you that what kind of gene people here have in common. It was reported by some media to outside countries but I can reaffirm and nod to myself that how catastrophe/crisis resistant these people are.
They have gone through post war destruction/reconstruction, multiple oil crises in 1970's and Kobe earthquake in 1994. As I actually live here and be part of community/society here, I feel their (and my) determination to come back. This is the country of being united where people are gladly taking a part to sacrifice for the whole. This was repeated many times in the country's history and I am sure it will repeat again this time. From bottom of my heart. I wrote a short article to explain this. Read here.
The Japanese Economy and the Forex market: an Insider View on How this Country can Survive the Recent Catastrophe..
Your ideas on the Japan's recovery and rebuilding haven't panned out. Those of us who bought into your recommendations are losers. What is your prognosis now?