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Alan Schram

Alan Schram

Posted: March 21, 2011 11:33 AM

Investing in the Wake of Japan's Crisis


Japan is an incredible civilization in many ways. It was reduced to rubble after WWII, yet became an extraordinarily rich country and the second largest economy within only a generation.

Today, however, it is hard to feel optimistic about their prospects. Despite what some Keynesian economists still believe, destruction is not beneficial for the country, spending does not create prosperity and tsunamis won't stimulate the economy.

Economics at its core describes choices made in a world of scarcity. The resources required for rebuilding Japan could have gone into other endeavors, and the money will now likely come from new government borrowing. This will exacerbate the deficit for what is already the most indebted developed nation (with a debt-to-GDP ratio of 200%), and should slow growth and hurt equity prices. Indeed, in 18 years of Keynesian experiments (1992 to 2010), Japan had an average of 0.85% annual GDP growth. Over the same period, the Nikkei 225 declined 55%.

More critically, last year Japan passed an important turning point, with negative implications: pension plans began selling assets to fund pension obligations. They had to, because Japan has the oldest population in the world: a median age of 45, almost a quarter of the population 65 years old or more, and a fertility rate of 1.27 children per woman, which is below zero population growth. For perspective, in 1960, when Japan was on its way to becoming an economic power, 49% of Japanese were under 25 years old and less than 8% were over 60.

Debt and demography will therefore limit their ability to fight back, and thus it is hard to be cheerful about Japan's future.

Yet there are intelligent ways to take advantage of the confusion in financial markets. There are plenty of solid U.S. and European companies on fire sale right now, and whose business will not be impacted in a significant way. Others will suffer losses but will clearly survive. Toyota Motors, to name one prominent example, is one of the most respected brands on earth. In the long run, the disastrous events in Japan are no more than a speed bump for them. And Toyota's stock price has been slashed more than enough to reflect the damage suffered by the company.

Another good example is Munich RE, one of the largest re-insurance companies in the world. With a balance sheet of over $200 billion, Munich RE will easily survive their exposure to Japan. The shares are down 15% over the past week and are trading below their book value and at a P/E of 8.5, paying a dividend of 5.7%.

Reinsurance of nuclear facilities does not generally extend to "Force Majeure," and in Japan the government, not private companies, will provide most of the compensation for earthquake and tsunami damage. In addition, large claims from Japan will drive catastrophe reinsurance prices higher, and insurance companies will be able to raise premiums.

After most disasters people panic and puke out shares of insurance companies without thinking. The solid ones come back in a big way. In 2005, hurricanes Katrina, Rita and Wilma caused losses of $100 billion. Yet the shares of most insurance companies made new highs in 2006. In fact, according to Citigroup, reinsurance stocks outperformed the S&P 500 for up to a year following the 16 largest global catastrophes.

The knee-jerk reaction to disaster is to panic and move to cash. Yet it rarely pays to act without thinking. Investing is about staying rational and having a low cost basis. As the old saying goes, you buy when there's blood in the streets, or in 21st century parlance, when there is nuclear meltdown in the streets. You buy uncertainty because you have to pay a high price when uncertainty recedes.

And as far as general U.S. equity markets are concerned, printing money has historically been good for stock prices. That was true when Nixon devalued the dollar in the early 1970's, and it was true when the Federal Reserve printed money to bail out Latin America in 1982. And of course it has been true throughout these quantitative easings.

In the first quarter of 2011 we had, so far, revolutions in Tunisia and Egypt, civil war in Libya, riots in several other Arab countries, and a huge earthquake, tsunami and nuclear meltdown in Japan. Yet the S&P 500 is still up for the year. What better sign for the market's underlying strength?


Alan Schram is the Managing Partner of Wellcap Partners, a Los Angeles based investment firm. Email at aschram@wellcappartners.com.