By Lior Alkalay, eToro Senior Analyst
It was little more than a year ago, a Friday, March 11th, a black day that can never be forgotten; a day when the entire world sat, transfixed by scenes so devastating that even Hollywood’s most creative couldn’t have imagined them. To a one, we can almost instantly, and with perfect, agonizing recollection, envision the scenes of terrified Japanese trying to flee the ominous huge black wave, created in the aftermath of a major earthquake, as it flooded their shores. The destruction was horrific; more than 9,000 deaths, 2,000 missing and 4.4 million people left homeless. As if the tsunami wasn’t enough, the flooding which followed ignited a nuclear disaster in the Fukushima compound. The radiation contaminated the entire Fukushima area, transforming entire cities and villages into “ghost towns,” while simultaneously destroying wide swaths of agriculture in the north east of Japan. And despite the death, destruction and shock to not just their homeland but their collective psyche, the Japanese people never lost their spirit, or their hope. No, throughout the ordeal they prevailed, and they did so with incredible, awe-inspiring dignity, calm, resolve and perseverance.
However, death and destruction were not the only damage; the earthquake and tsunami had a massive economic cost, as well. Estimated damage from the tsunami and radiation from the damaged nuclear plants are estimated to be more than $180 billion. And that estimate is only the direct effect, not taking into consideration secondary effects of loss of jobs, and the potential economic costs of lost agrarian lands and other long term damage as a result of the flooding and radiation. And while the world bore witness to the noble spirit of the Japanese people who valiantly withstood the after-effects of the disaster, the economic community, which had witnessed the Japanese economy sinking and drifting lower for much of the last 20 years, believed that this would be the last straw, that this – the latest and greatest damage – would finally eclipse Japan, the land of the rising sun. In that belief, they would be proved wrong.
The curse of the Yen
Most investors and not a few analysts had estimated that 2011 would be a difficult one for Japan, with a serious economic downturn as a large proportion of Japanese industry had been paralyzed for a prolonged period of time; Barclays Bank estimated the damage to be as much as 3% of GDP. But the Japanese economy, very much like the Japanese character, endured and was on the path to recovery. Eventually, despite the devastation, there was a remarkable rebound in Japanese business activity with GDP for 2011 contracting by only -0.47%, a great and welcome surprise to most economists. And this is even as Japan was forced to shift away from nuclear energy, and suffered with increased energy costs.
Of course, economists continue to downgrade their expectations of Japanese growth, pointing to the fact that Japan was already at the end of two “lost” decades of dismal growth and tends to suffer from chronic deflation that has been worsened by the strengthening Yen which heavily weighs on exports.
If there were one key characteristic which could be considered the real drag on the Japanese economy over the past two decades, it would certainly be the strength of the Japanese currency. Although the economic devastation of the natural disasters are enormous, it is in the strong Yen that has continued to weigh so heavily on the Japanese economy, to the point that it has become practically numb, drifting and slowly sinking.
Japan is an export-oriented country with the total of all exports valued at $800 billion (2011 figures) and so, like all exporting countries including China and Brazil, a higher valued currency is significantly hurting exporters’ profits. Since the 1990s, the Yen has appreciated considerably, rising more than 50% in relation to the U.S. Dollar’s value. An aggressive appreciation by all means, but even more so when you consider that Japan is not an emergent economy like China, where workers earn a few hundred dollars a month, but a fully developed, modern economy with average wages that are among the highest in the world. A 50% rise in the Yen’s value, therefore, means that Japanese manufacturing costs had spiked quickly. It is only recently that we have begun to bear witness to the severe effects on Japanese exporters; Sony, the electronics giant, announced that it was letting go some 10,000 workers, equivalent to 6% of its workforce, and Toyota, the automotive behemoth, estimated the impact of a strong Yen on its operational profit to be ¥250 billion.
The vicious cycle
The Japanese unit labor cost (effectively, a calculation of workers) is so high that Japan is suffering a wave of falling wages and, as consequence, falling prices. When prices fall, citizens prefer to save rather than spend and if the inflation rate is negative, even a bond yielding zero is actually positive, right? This then is the start of a vicious cycle – Japanese citizens saving, and pushing prices even lower and Japanese bonds even higher. In response, the Japanese government “tries” to tackle it by spending more, only to find that its huge bond market has been pushing the private sector’s bond market to the sidelines, because no business can compete with the safety inherent in a government bond. So prices keep falling, and investment inflows keep flowing to the government instead of business and the entire country becomes wrapped up in red tape. The cycle repeats; prices fall, bonds rise, and the Yen rises still more, and on and on and on again…
Investors challenge economist
Economists view Japan as an economic powerhouse in decline, and they stress rising energy costs alongside the government’s hesitancy to pass a bill which could restore the economic damage spawned from the tsunami. Economist also note that the Japanese government tends to have a somewhat laissez faire attitude as regards the global outlook for rising energy costs, which could have stemmed from their near total and long-term reliance on nuclear energy, and in the absence of that nuclear power, they have no clear policy direction. Add to that the sticky Yen factor and it all comes as a huge drag, pulling down the land of the rising sun. In fact, economists’ stridently argue that the government’s lack of a long-term strategic plan and the frozen political climate suggests that the chance for a positive change is slim and that Japan’s ultimate decline will undoubtedly occur.
Investors, however, are starting to view things differently and increasingly diverging from the consensus economic view. They are becoming increasingly optimistic that the land of the rising sun will not just rise, but shine. When looking at the Nikkei 225, Japan’s premier index and ultimately the embodiment of investors’ sentiment, the picture is contrastingly bright. Since the global rally in equities started back in November, and through March 2012, the Nikkei outperformed most major indices including the S&P500, FTSE100, and even the Hang Seng, gaining a staggering 17.9% this year alone. It seems that while economists were busy debating how Japan could pull itself out of the muck and mud, the investment community has brushed off political worries and saw instead the enormous potential in the Japanese economy for growth and prosperity. Investors, in fact, are already witnessing a change.
Investors have pointed out some strong opportunities; first and foremost among them is the change to the Bank of Japan’s stance. While economists talk of the need for political change, investors point to the shift of the BoJ which set an inflation target of 1%.In point of fact, that means that the BoJ has become closer to the U.S. Federal Reserve in terms of monetary policy, by preparing to spur the economy with more asset purchases, partial money printing and easing credit until inflation returns. However, the setting of an inflation target could be considered a mere ploy which hides the BoJ’s real intent, i.e. to copy the Fed’s philosophy of printing money to spur growth. The “Bernanke cure” has, in fact, showed remarkable success considering that the U.S. has been able to stabilize growth after the apocalyptic credit crunch it experienced.
Investors see that as a major fundamental change; if inflation starts to emerge in Japan, encouraged by the BoJ, then the close to zero yields of JGBs will stop being attractive and Yen demand will eventually evaporate, and a weaker Yen can take Japanese growth a long long way. This process has already started and the Yen has now firmly stabilized above the 80 level; some earlier critics, including Goldman Sachs’ Jim O’Neil, who coined the term “BRICs,” is now predicting that the Yen Dollar rate is destined to reach 100, which will be exceedingly positive for Japan. Investors also point to Japanese corporations as attractive, valuation-wise, and which on the whole provide good long-term value; another way of saying, “we believe in Japan’s ability to recover.”
So, who is right, the pragmatic economists or the increasingly optimistic investors? That is yet to be seen, but what I can say with all confidence is this; when it comes to identifying opportunities, history has shown, time and again, that investors overwhelmingly have the upper hand.
Economic recovery likely to prove a ‘stuttering’ affair
By Rupert Thompson, Chief Investment Officer at Kingswood
Equity markets continued their upward trend last week, with global equities gaining 1.2% in local currency terms. Beneath the surface, however, the recovery has been a choppy affair of late. China and the technology sector, the big outperformers year-to-date, retreated last week whereas the UK and Europe, the laggards so far this year, led the gains.
As for US equities, they have re-tested, but so far failed to break above, their post-Covid high in early June and their end-2019 level. The recent choppiness of markets is not that surprising given they are being buffeted by a whole series of conflicting forces.
Developments regarding Covid-19 as ever remain absolutely critical and it is a mixture of bad and good news at the moment. There have been reports of encouraging early trial results for a new treatment and potential vaccine but infection rates continue to climb in the US. Reopening has now been halted or reversed in states accounting for 80% of the population.
We are a long way away from a complete lockdown being re-imposed and these moves are not expected to throw the economy back into reverse. But they do emphasise that the economic recovery, not only in the US but also elsewhere, is likely to prove a ‘stuttering’ affair.
Indeed, the May GDP numbers in the UK undid some of the optimism which had been building recently. Rather than bouncing 5% m/m in May as had been expected, GDP rose a more meagre 1.8% and remains a massive 24.5% below its pre-Covid level in February.
Even in China, where the recovery is now well underway, there is room for some caution. GDP rose a larger than expected 11.5% q/q in the second quarter and regained all of its decline the previous quarter. However, the bounce back is being led by manufacturing and public sector investment, and the recovery in retail sales is proving much more hesitant.
China is not just a focus of attention at the moment because its economy is leading the global upturn but because of the increasing tensions with Hong Kong, the US and UK. UK telecoms companies have now been banned from using Huawei’s 5G equipment in the future and the US is talking of imposing restrictions on Tik Tok, the Chinese social media platform. While this escalation is not as yet a major problem, it is a potential source of market volatility and another, albeit as yet relatively small, unwelcome drag on the global economy.
Government support will be critical over coming months and longer if the global recovery is to be sustained. This week will be crucial in this respect for Europe and the US. The EU, at the time of writing, is still engaged in a marathon four-day summit, trying to reach an agreement on an economic recovery fund. As is almost always the case, a messy compromise will probably end up being hammered out.
An agreement will be positive but the difficulty in reaching it does highlight the underlying tensions in the EU which have far from gone away with the departure of the UK. Meanwhile in the US, the Democrats and Republicans will this week be engaged in their own battle over extending the government support schemes which would otherwise come to an end this month.
Most of these tensions and uncertainties are not going away any time soon. Markets face a choppy period over the summer and autumn with equities remaining at risk of a correction.
European trading firms begin coming to terms with the new normal
By Terry Ewin, Vice President EMEA, IPC
In recent weeks, the phrase ‘never let a good crisis go to waste’ has received a large amount of usage. Management consultancies, industry associations and organisations, including the Organisation for Economic Co-operation and Development (OECD) have all used it in order to discuss how the current crisis, caused by the Coronavirus pandemic, presents an opportunity for new and worthwhile change.
The saying is also commonly used to indicate that the destruction and damage that is caused by a crisis gives organisations the chance to rebuild, and to do things that would not have previously been possible. This has the potential to impact financial trading firms, where projects that this time last year would not have made much sense now appearing to be as clear as day. In Europe, banks and brokers alike are beginning to think about what life will look like post-pandemic, and how their technology strategies may need changing.
We can think of three distinct phases when it comes to a crisis. Firstly, there is the emergency phase. This is followed by the transition period before we come to the post-crisis period.
Starting with the emergency phases, this is when firms are in critical crisis management mode. Plans are activated to ensure business continuity, and banks and brokers work to ensure critical functions can still take place so as to continue servicing their clients. With regards to the current crisis period, both large and small European banks and brokers were able to handle this phase relatively well, partly due to the fact that communications technology has reached the point where productive Work From Home (WFH) strategies are in place. For example, cloud-connectivity, in addition to the use of soft turrets for trading, has enabled traders from across the continent to keep working throughout lockdown. From our work with clients, we know that they were able to make a relatively smooth transition to WFH operations.
In relation to the current coronavirus crisis, we are in the second phase – the transition period. This is the stage when financial companies begin figuring out how best to manage the worst effects of the ongoing crisis, whilst planning longer-term changes for a post-crisis world. One thing to note with this phase, is that no one knows how long it will last. There is still so much we don’t know about this virus. As such, this has an impact on when it will be safe for businesses to operate in a similar way to how they were run in a pre-pandemic world. But with restrictions across Europe starting to be eased, there is an expectation that companies will start to slowly work their way towards more on-site trading. For example, banks are starting to look at hybrid operations, whereby traders come in a couple of times a week, and WFH for the rest of the week. This will result in fewer people in the office building, which makes it easier to practise social distancing. It also means that there is a continued reliance on the technology that enables people to WFH effectively.
Finally, we have the post-crisis period. In terms of the current crisis, this stage is very unlikely to occur until a vaccine has been developed and distributed to the masses. Although COVID-19 has caused mass economic disruption, many analysts are predicting a strong rebound once the medical pieces of the puzzles are put into place. It may not be entirely V-shaped, but the resiliency displayed by the financial markets thus far suggests that it will be healthy.
Currently, many European trading firms are taking what could be described as a two-pronged approach.
The first part of this consists of planning for the possibility of an extension to phase two. Medical experts have suggested that there could be some seasonality to the virus, with the threat of a second wave of COVID-19 cases in the Autumn meaning that the risk of new restrictions remains. If this comes to fruition, there would be a need for organisations to fine-tune their current WFH strategies and measures, and for them to take greater advantage of the cloud so as to power communications apps.
The second component consists of firms starting to think about the long-term needs of their trading systems. Simply put, they are preparing themselves for the third phase.
It is in this last sense, that the idea of never letting ‘a good crisis go to waste’ resonates most clearly.
Currency movements and more: How Covid-19 has affected the financial markets
The COVID-19 pandemic has been more than a health crisis. With people forced to stay indoors and all but the most essential services stopped for multiple weeks, economies have suffered and financial markets have crashed. Perhaps the most public and spectacular fall from grace during the early stages of the pandemic was oil. With travel bans in place around the world and no one filling up at the pumps, the price of oil plummeted.
Prior to global lockdowns, US oil prices were trading at $18 per barrel. By mid-April, the value had dropped to -$38. The crash was not only a shocking demonstrating of COVID-19’s impact but the first time crude oil’s price had fallen below zero. A rebound was inevitable, and many traders were quick to take long positions, which meant futures prices remained high. However, with stocks piling up and demand sinking, trading prices suffered. Unsurprisingly, it’s not the only market that’s taken a knock since COVID-19 struck.
Financial Markets Fluctuate During Pandemic
Shares in major companies have dipped. The Institute for Fiscal Studies compiled a round-up of price movements for industries listed by the London Stock Exchange. Tourism and Leisure have seen share prices drop by more than 20%. Major airlines, including BA, EasyJet and Ryanair have all been forced to make redundancies in the wake of falling share prices. The automotive industry has also taken a knock, as have retailers, mining and the media. However, in among the dark, there have been some patches of light.
The forex market has been a mixed bag. As it always is, the US dollar has remained a strong investment option. With emerging markets feeling the strain, traders have poured their money into traditionally strong currency pairs like EUR/USD. Looking at the data, IG’s EUR/USD price charts show a sharp drop in mid-March from 1.14 to 1.07. However, after the initial shock of COVID-19 lockdowns, the currency pair has steadily increased in value back up to 1.12 (June 25, 2020). The dominance of the dollar has been seen as a cause for concern among some financial experts. In essence, the crisis has highlighted the world’s reliance on it.
Currency Movements Divide Economies
In any walk of life, a single point of authority is dangerous. Indeed, if reliance turns into overreliance, it can cause a supply issue (not enough dollars to go around. More significantly, it could cause a power shift that gives the US too much control over economic policies in other countries. Fortunately, other currencies have performed well during the pandemic. Alongside USD and EUR, the GBP has also shown a degree of strength throughout the crisis. However, these positive movements haven’t been shared by all currencies.
The South African rand took a 32% hit during the early stages of the pandemic, while the Mexican peso and Brazilian real dropped 24% and 23%, respectively. Like the forex market, other sectors have experienced contrasting fortunes. Yes, shares in airlines and automotive manufacturers have fallen, but food and drug retailers have seen stocks rise. In fact, at one point, orange juice was the top performer across multiple indices. With the health benefits of vitamin C a hot topic, futures prices for orange juice jump up by 30%. The sudden surge had analysts predicting 60% gains as we move into a post-COVID-19 world.
Looking Towards the Future through Financial Markets
The future is always unknown and, due to COVID-19, it’s more uncertain than ever. However, the financial markets do provide an indication of how things may change. The performance of USD and EUR in the forex markets suggest there could be a lot more trade deals negotiated between the US and Europe. The surge in orange juice futures suggest that health and wellness will become a much more important part of our lives. Even though it was already a multi-billion-dollar industry, the realisation that a virus can alter the face of humanity has given more people pause for thought.
Then, of course, there’s the move towards remote working and socially distance entertainment. From Zoom to Slack, more people will be working and playing from home in the coming years. The world is always changing, but recent have events have made us appreciate this fact more than ever. The financial markets aren’t a crystal ball, but they can offer a glimpse into what we can expect in a post-COVID-19 world.
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