Japan earthquakes remind investors of ever-present risk

Aug 13, 2009, 4:16 a.m. EST
By Lisa Twaronite, MarketWatch

Third strong quake in four days lead analysts to ponder worst-case scenarios

TOKYO (MarketWatch) -- The third strong earthquake in four days shook Tokyo early Thursday, reminding investors that the threat of a massive temblor looms heavily over the world's second-largest economy and leaving them to ponder the likely market impact.

The 6.7-magnitude quake that stuck at 7:49 a.m. Thursday morning local time was centered in the Pacific Ocean about 200 miles southeast of Tokyo, according to the U.S. Geological Survey. No injuries or damages were reported.

It followed a magnitude-6.5 earthquake to about 100 miles southwest of Tokyo two days earlier, which left one person dead, dozens injured and closed a major roadway connecting Tokyo with Western Japan.

Another offshore quake with an estimated magnitude of 7.1 struck the Izu Islands to the west of Tuesday's quake on Sunday evening. All three quakes were felt in the capital, though none occurred during market hours.

Japanese assets, including the yen, would be an obvious "sell" immediately after a major disaster here. Whenever the ground trembles under Tokyo trading floors, the yen tends to skip against other major currencies, and the stock market usually sheds some points.

But in the longer term, a clear directional call is impossible. The quake's magnitude, the state of the Japanese and global economies in the period leading up to the event, as well as the recent bias of yen trading preceding it, would all be factors, said Patrick Bennett, a currency strategist at Société Générale in Hong Kong.

"A huge earthquake would of course be a terrible tragedy, and as in the case of [the Japanese port city of] Kobe, would impact growth. But in the recovery/rebuilding process there will be some divergence in company performances," he said.

In the rebuilding phase that follows a disaster, winners and losers emerge. Insurers are likely to liquidate some overseas assets in order to pay claims, and that repatriation could accelerate yen appreciation.

A 2007 study by ABS Consulting Inc. and its unit EQECAT Inc. found that a large quake could lead Japan's chemical industry to suffer financial losses equal to more than two years of pre-tax earnings, while the precision machinery and petroleum industries could suffer damage equal to more than one year of pre-tax earnings.

Other industry groups that also have significant loss exposure were steel, non-ferrous metals, autos, electronics and pharmaceuticals, the study said.
Advanced preparedness

Japan is among the most earthquake-conscious societies, as it is struck by an estimated 20% of the world's earthquakes of magnitude 6 or greater.

Schools, and even some business, hold regular disaster drills, particularly on the Sept. 1 anniversary of the 1923 Great Kanto earthquake and fire which claimed about 140,000 lives in Yokohama and Tokyo.

Japan's advanced quake preparedness was likely the main reason casualties and damages from this week's strong temblors were lower than they would have been in a country without such preparations and seismic requirements in place.

Even so, companies reported quake-related disruptions. Corning Inc. /quotes/comstock/13*!glw/quotes/nls/glw (GLW 16.48, +0.25, +1.54%) said the Tuesday earthquake disrupted production at its LCD glass-manufacturing facility in Shizuoka. The plant manufactures glass substrate for Sharp Corp. /quotes/comstock/!6753 (JP:6753 1,083, +11.00, +1.03%) and other Japanese LCD panel makers.

Toshiba Corp. /quotes/comstock/!6502 (JP:6502 464.00, +7.00, +1.53%) subsidiary Hamaoka Toshiba Electronics Corp. also reportedly suffered damage at their LED factory in the area.

A quake-triggered landslide also destroyed part of the Tomei Expressway between Tokyo and Nagoya, which remained closed Thursday.

Chubu Electric Power Co. /quotes/comstock/!9502 (JP:9502 2,205, -5.00, -0.23%) automatically halted operations at two reactors at its nuclear plant in Shizuoka prefecture after the quake, which briefly cut power to thousands of homes. The utility said it would temporarily use liquefied natural gas units to offset the loss of capacity.
'Bad for the economy'

Two strong earthquakes with 6-plus magnitudes caused casualties and damages in the northern Niigata region in 2004 and 2007, but Japan's most devastating recent seismic event was Kobe's 7.3-magnitude quake in 1995. It killed more than 6,400 people and caused damages estimated around 2% of Japanese gross domestic product.

In a worst-case scenario, a Kobe-sized quake originating in the northern part of Tokyo Bay could kill up to 11,000 people in the greater Tokyo area, according to a 2005 study by the Japanese Cabinet Office's Central Disaster Management Council.

"An earthquake, as with any disaster, is bad for the economy despite many commentators' arguments that the earthquake would stimulate the Japanese economy through the demand stimulus that results," economist Warwick McKibbin wrote in a 1997 policy paper for the Washington, D.C.-based Brookings Institution.

Japan's experience in 1995 followed some traditional models, he said, in which "the yen appreciates, GDP falls, the share market drops, and long-term real interest rates rise slightly."

The initial impact, he said, is "a direct negative effect of the lower capital stock on aggregate supply," which brings down share prices and, in turn, reduces private consumption.

But those lower prices eventually attract buyers, he said, as foreign capital flows into the country "in response to the higher expected rate of return. Thus the yen appreciates and the current account deteriorates, reflecting the capital inflow."

Lisa Twaronite reports for MarketWatch from Tokyo.