Editor's note: This publication is running a number of commentaries by investment and wealth management strategists and portfolio managers about the recent terrible events in Japan, and the likely impact on the country, world markets, and further ahead, on wealth management itself. We invite readers' feedback as events continue to unfold.

Sheila Hartnett-Devlin, CFA, vice president and client portfolio manager at American Century Investments.

Charles Kime, an American Century Investments research analyst who covers Japan for the International Discovery and International Opportunities portfolios was in Japan during the earthquake and has provided some valuable background and insights to the disaster.

In his opinion, on a broad view, the tragedy in the Tohoku region will not have the impact that the Kobe earthquake had in 1995. The Kobe (or Great Hanshin) Earthquake on 17 January 1995, registered 6.8 on the USGA scale. It was a direct hit under the city of Kobe, not at all like the Tohoku earthquake which was 81 miles offshore from the city of Sendai and 224 miles from Tokyo, and the resulting tsunamis are the primary cause of loss of life.

The Kobe earthquake knocked $100 billion off Japan’s GDP. Given the size of the Tohoku region as a percent of Japan’s GDP (less than 4 per cent) and population (less than 2 per cent), it is expected that this earthquake will not have the same economic impact. Sendai, the epicenter of the quake, is a smaller city with one million people.

This does not mean that the industrial heartland of Japan between Nagoya and Osaka has been affected; it has not. Tokyo, the financial center, is back open for business; there was no major damage there. The Bank of Japan has flooded the economy with cash, pumping $183 billion into money markets this weekend - a record amount.  

Sector impacts

It is now estimated that the macroeconomic impact of the earthquake and tsunami will in some part be offset by the reconstruction efforts. The near-term impact will reduce the first half estimates for GDP growth with this shortfall and will then be offset by increased estimates for growth in the second half of the year. In total, estimates for 2011 GDP growth will range between 1.5 per cent and 2 per cent and slightly higher moving into 2012. While the broad impacts of the earthquake in Japan are still being assessed, we do have some information about the impact on sectors and industries. In general, Tohoku is not a central area for Japanese industrial machinery builders. For example, Japan represents 15 per cent of Komatsu’s sales with production sites in Hitachinaka City and Ibaraki. Japan represents 25 per cent of Fanuc’s sales with production sites in Tsukuba City and Ibaraki. As a result of the earthquake, there might be some short-term delays in delivery of assembled machines and components for export. For international capital goods companies, the impact is minimal, as less than 1 per cent revenues come from Japan.  

The technology sector is one of the sectors most associated with Japan and Asia as a whole. Much of the machinery is finely tuned and any disruption leads to an automatic shutdown as machines need to be recalibrated. This is especially true for the semiconductor industry, with companies such as Texas Instruments and Freescale Semiconductor among those impacted.

In the auto sector, several manufacturers have noted that they will shut down production sites in Japan temporarily and, in some cases, shift production to other areas in the US, Europe and other countries. Toyota has one model, the hybrid Prius, for which Japan is the only manufacturing site. However, as a major manufacturing base for components, the disruption in production will have ripple effects through the supply chain.  

In addition to technology and autos, the Japanese consumer is also an important influence on the global economy. In the retail sector, Japan accounts for 20 per cent of Coach’s sales and 9 per cent of LVMH’s sales. In total, 10 per cent of sales in the retail industry are generated in Japan. Tourism will also be negatively impacted from the loss of Japanese tourists abroad. Leisure and travel stocks in Korea were negatively impacted today as 35 per cent of visitors to Korea come from Japan. Health care stocks are not expected to see large negative impacts; multinational companies such as Novo Nordisk and Novartis see Japan accounting for 8.5 per cent of sales, while Japan accounts for 12 per cent of Roche’s sales.

Commodities will be slightly impacted due to lower demand from Japan initially. However, as the country rebuilds there will be increased demand for steel, positively impacting all companies leveraged to infrastructure development  

Financial companies do not appear to have above-average risk following this tragedy. Ultimately, banks will have to lend to companies to rebuild, and the consumer will have to spend to refurbish goods lost in the destruction. The markets are operating within the normal circuit breakers meant to control volatility, and the Bank of Japan has shown its willingness to provide funds to keep the system operating.  

Perhaps the biggest impact to the output from Japan will be from the disruption to power as the country copes with a reduction in its energy sources. Approximately 30 per cent of Japan’s energy is nuclear and 20 per cent of the nuclear energy is now offline. In response to that reduction, Japan is implementing rolling power outages throughout the country and these outages are expected to last through April. The Fukushima nuclear plant complex produced 4.7GW of power in total (10 per cent of Japan’s capacity), but three of the six reactors at Fukushima were already shut down when the quake hit for scheduled maintenance—they’re all nearly 40 years old—so the two that have been affected only account for 1.2GW, or 2.5 per cent of Japan’s nuclear capacity. Nuclear power is 30 per cent of Japan’s total electricity power grid, so that 1.2GW is only 0.75 per cent of Japan’s total electricity capacity.  

Of the Fukushima nuclear plants, the Number 1 reactor (or Daiichi, commissioned in 1970, only 460MW) and Number 3 reactor (Daisan, 1976, 784MW) reactors were old and plans to decommission them were in place. As of March 15, the situation surrounding the reactors has continued to worsen with hydrogen explosions at reactors Number 1 and Number 3 and a fire at reactor Number 4. As a result, radiation levels had exceeded legal limits in the Ibaraki Prefecture, and with wind directions shifting, there were concerns of radiation exposure in Tokyo. 

There will be short-term and medium-term beneficiaries of this tragedy in the energy sector. Japan is the largest importer of liquid natural gas (LNG) in the world (30 per cent of global demand), and LNG and fuel oil are the two fuel sources that will be used to power electricity generation lost via nuclear capacity in Japan. Replacing lost nuclear production from the two nuclear sites most impacted would represent a demand call on the LNG market approximately equal to 5 per cent. This will likely expand the LNG premium of cargoes going to Japan versus Europe, which will provide a modest tailwind to companies such as BG Group PLC’s LNG earnings over the next year or two. Finally, if the world’s nuclear investing activities stall or pause for any extended period of time, LNG demand over the medium term should accelerate.  

Summary  

Importantly, the key to understanding the impacts of this tragedy is that industrial Japan has not been greatly impacted. Near term and medium term, there will be a focus on rebuilding which will have a positive impact on the economic growth of the country and the suppliers who will benefit from the infrastructure spending. The government has already shown its willingness to provide support by injecting a record amount of cash into the financial system.

As with all tragedies, the financial markets will bear additional headline risk until there is greater information about the longer-term impacts on companies and their earnings outlooks. The American Century Investments global and non-US strategies managed in New York have had lower exposure to Japanese equities relative to the broader indices.