March 17, 2011

Japan Quake 'Unlikely' to Induce Large Drop in Equity Values: GMO's Inker

Global equities could fall, but earthquake 'unlikely to have a material impact'

Ben Inker, head of asset allocation for GMO, a global investment management firm, wrote in a market commentary on Tuesday that Japan has been a relatively cheap market in the developed world in the past; following the earthquake on March 10, and with the market down 20%, it's significantly cheaper now.

Investors' biggest concern, Inker wrote, is that global equity markets are expensive and the return to risk is low. That, combined with the lingering effects of the credit crisis, could lead to a "rethink of risk taking," even if conditions in Japan don’t lead to a significant drop in the fair value of global equities. Inker noted that global equities are between 25% and 30% overvalued as it is, and "they have every right to fall significantly." If the disasters in Japan lead to that fall, Inker expects it will affect equity returns for "a few months or a year or two."

"But they are very unlikely to have changed the true fair value of global equities by a detectable amount," he wrote.

Inker noted that the economic cost and the human cost have different impacts.

"However horrific the human cost, economically, most disasters are hard to spot in the data," he wrote. Any fall in GDP (and a fall isn't necessarily guaranteed) will usually experience a "rapid" bounce back. Furthermore, "given the long duration nature of equities, where the bulk of value comes from the present value of dividends that will be paid 10 or more years in the future, we believe this event is unlikely to have a material impact on the long-term fair value of corporate Japan," he added.

Inker acknowledged the country's significant challenges, pointing specifically to the nuclear power business, but indicated "greater efficiency in factories and homes could well result from that particular challenge."

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