28 February 2020
China has become an industrial cornerstone for many countries, with Japan being no exception. Bearing this in mind, Reiko Mito, Ernst Glanzmann and Lukas Knueppel of GAM Investments share their thoughts on the impact coronavirus might have on the Japanese economy.
Impact on current economic activities
In the short term, the coronavirus has a negative impact on many Japanese companies.
We believe the outlook for the second half of the year is likely to improve, considering that global economic activity had been recovering prior to the outbreak of the coronavirus. Each month, the trend was improving as year-end approached.
After the Lunar New Year, companies have been addressing the production and supply chain in China. For example, air conditioning manufacturer Daikin has one of its production factories in Wuhan. Therefore, we anticipate it would need to look into the inventory and supply in the upstream across multiple layers. It may need to switch the supply from other factories in Japan to other companies in other regions. Many companies seem to have stock for at least several weeks. Meanwhile, there are closed cities and roads, which require them to find other ways of travel. On the sales front, face-to-face meetings are being avoided at both the end customer and agency levels.
Meanwhile, at the request of the government, people in Japan have increasingly started to work from home and use video conferencing systems. The practice has been expanding worldwide. As a result, the spread of 5G, large capacity data centres and high-speed servers are expected to grow faster than previously expected.
Is this a temporary slowdown?
As the market falls, pessimism often increases; however, it would be excessive to consider this as a lasting economic crisis.
The underlying demand and infrastructure are intact, which we feel makes it possible for a fast restart. There is no broad-based issue in credits whatsoever, except for some working capital constraints for small-sized companies or specific industries, such as tourism. The data for household, corporate and government are all sound, which makes us believe the recovery should be faster and steeper than normal.
Although it is unclear when exactly the economic situation will return to normal, the signs of recovery are likely to emerge around the middle of the year, as the reasons for the slowdown are not complicated.
For the year ending 31 March, companies usually publish full-year earnings guidance from late April to early May. It is customary to formulate guidance around the end of February to March, so this would coincide with the worst period of the coronavirus. Consequently, pessimistic guidance is inevitable.
Guidance is often a positive catalyst for stock prices; however, it is our opinion this is unlikely this year. The markets may consider it as the last bad news before a rebound.
About theoretical corporate value
In order to quantify the theoretical impact of the coronavirus on the aggregate corporate value, we use our discounted cash flow model and enter an assumption that the coronavirus disruption continues for six months, leading to profits declining 50% in the coming twelve months, while maintaining the estimates of the year ahead untouched. Assuming that a company survives 20 years, the company's value will theoretically decrease by a mere 4% based on these assumptions.
The markets tend to be short-termist and fall down due to prevailing news flow; however, with the exhaustion of bad news, we anticipate that we will return to a recovery trend.
In the short term, we believe increased volatility is inevitable.
The risk is that economic downturn kicks in following the coronavirus, causing corporate investment and consumption to materially slow down.
Having said that, given that the fundamentals of the companies had been improving before the outbreak of coronavirus and that coronavirus itself is a temporary event, we maintain a positive outlook in the long term.
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development. Reference to a security is not a recommendation to buy or sell that security.