Evercore Pan Asset

First came the attempts to cool the emerging market economies down with higher interest rates and tighter banking controls. Then came the contemporaneous revolts in Tunisia, Egypt, Yemen, Bahrain and Libya. Now we have witnessed the terrors of the Japanese earthquake and tsunami. The early weeks of 2011 have hurled lots of bad news at the markets. 
 
We have all been moved by the troubling pictures from Japan. The devastation wrought by tremors and waves is of biblical proportions. Our hearts go out to all the people who have lost loved ones, lost their homes and all their possessions. Nature’s raw power has done untold damage to the north of that country.
 
It is investors’ jobs to evaluate the impact all this may have on the output and economic achievement of the world’s third largest economy, once we have sent our condolences and wished all speed to the rescuers who set about their task of helping those in trouble. The economic news is considerably better than the human misery created by the force of the water. The damage is confined to a limited part of the north, well beyond the crucial Tokyo heartland of the Japanese economy. The great technical and industrial power of the Japanese will be able to move the debris, clear the roads, and start the task of rebuilding. Later this year and next, there will be a stimulus from the extra money spent on new roads and railway lines, homes and factories, as they set about the big job of reconstruction.
 
In the short term the economic news is bleaker. The damage done to nuclear power stations will temporarily leave Japan short of power. A system of planned black outs will affect industry as well as homes. Many large companies are shutting their works altogether whilst families and communities pick themselves up after the blow to their islands. The nuclear incident remains critical and could still lead to worse trouble with further meltdown and fall out. Output and incomes will be lower for the first half of 2011 as a result. There will be a two way pull on the yen. The Bank of Japan has created more money immediately to take some of the pressure out of the markets. This will tend to depress the value of the currency. Meanwhile Japanese companies and individuals may sell foreign bonds and other investments and repatriate money to help them pay the bills of the disaster, serving to prop the yen. 
 
The first reaction of markets was to mark Japanese shares down sharply, but not to do much to other shares in other centres. Investors seemed to think that the short term damage to Japanese output would be followed by some recovery, though Japan herself has to shoulder the burden of the extra costs and dislocation. If Japan reappraises nuclear power in an earthquake zone, that in the medium term means more construction of conventional power plants. The bigger threat to markets remains the possibility that the situation in the Middle East will deteriorate further, triggering higher prices for oil which in turn will slow the world economy more. Indian inflation remains too high and points towards the need for further monetary tightening there. China is having more success at curbing price rises.
 
Markets can only take so much uncertainty and damage to production and output. 2011 has so far been an unlucky year, leading to poor returns from most markets so far. The run of bad news might keep interest rates lower for longer, and will add Japanese monetary looseness to US quantitative easing. It is only a matter of time, however, before the US too will have to do more to curb its deficit and move closer to more normal levels of interest rates. Investors should not expect too much from risk assets this year. It is a year when you could discover why they are called risk assets, as the world is accident prone. The easy money model designed to get out of the Credit Crunch is running out of road. Returns on cash are low, but at least cash does not lose you money from market movements. Having some cash is no bad idea with all the dangers around.

As published in Investment Week