Investment

COMMENTARY
March 17, 2011

Jon Glidden, CFA®

Director of Manager Research

Calamity in Japan
KEY POINTS
• The Japanese economy will be damaged in the short run by the major earthquake and Obviously tremendously
tsunami that struck on March 11, as well as ensuing aftershocks and explosions at Japanese
nuclear reactors. In time, we expect Japanese economic growth to be temporarily stimulated painful in human terms,
by rebuilding efforts. This pattern has been repeated many times during natural disasters.
the disasters in Japan
• We believe investors may be overreacting, if only slightly, to the calamity in Japan,
particularly with regard to equity price declines outside of Japan. Absent additional disasters, may not inflict deep or
long-term global economic growth is unlikely to be materially affected by the events in
Japan.
lasting damage on the

• Most high-net-worth investors whose portfolios reflect our asset allocation strategy global economy or
recommendations should have had, as of the beginning of March, a modest 1–5% of their
assets invested in Japanese equities. financial markets. We
• In response to the disasters, we have advised our strategy-following clients to eliminate are concerned about the
their overweighted stakes in large-capitalization U.S. growth stocks in favor of a neutral
“investment style” mix (50% growth / 50% value) among U.S. large caps. Technology stocks possibility of higher
account for much of large-cap U.S. growth stock indices, and technology firms may be hurt
by Japanese supply disruptions. inflation, owing to

• Clearly, meaningful risks remain in Japan, the greatest being the possibility of a complete increased demand for
meltdown of a nuclear reactor.
The major earthquake and tsunami that struck northern Japan on March 11 and the ensuing fossil fuels as a replace-
aftershocks and explosions at nuclear reactors have claimed untold thousands of lives. The
ment for nuclear power.
survivors face many years of degraded living standards. We try, however, to view the investment
impact of crises through the dispassionate lenses of global economic growth, inflation, and
liquidity. From this perspective, we believe the direct impact of the earthquake and tsunami
will be comparatively small. Indeed, we believe the crises may have caused a slight overreaction
among investors. The Japanese economy will be damaged in the short run. Further on, Japanese
economic growth should be significantly, if temporarily, stimulated by rebuilding efforts.
Unfortunately, the structural economic problems that have plagued the nation for the last
two decades are unlikely to be remedied by rebuilding. A material, if indirect, concern is the
potential for a shift in global sentiment regarding nuclear power, a reduction in which could
increase reliance on fossil fuels for energy generation.

©2011 Wilmington Trust Corporation. All rights reserved.

Investment COMMENTARY
March 17, 2011
Figure 1:
A major economy, declining in global importance
14%
12%
10%
8%
6%
4%
9.8
2%
0%
1969 1972 1975 1978 1981 1984 1987
Japan's share of global GDP
Source: Economic Research Service of the U.S. Department of Agriculture
The Japanese economy: Large but stagnant
Japan’s economy is the world’s third largest, trailing only
the economies of the United States and China. In 2010, it
accounted for an estimated 8.7% of the global production
of goods and services, according to the Economic Research
Service of the U.S. Department of Agriculture. Last year,
as shown in Figure 1, the nominal value of goods and
services produced in Japan grew for the first time in 19 years;
remarkably, nominal gross domestic product (GDP) shrank
every year between 1992 and 2009. On an inflation-adjusted
basis, the country’s economic performance has been less woeful:
Real (inflation-adjusted) GDP grew in 14 of those 18 years.
The average rate of real growth in that span was just 0.7%—
1.6% ignoring the four years that saw contractions in real GDP.
The difference between nominal and inflation-adjusted rates
of Japanese growth reflects the persistent deflation—steadily
falling prices—that has inhibited consumption and encouraged
high rates of personal saving. Over approximately the last
five years, Japan’s contribution to real global growth has been
2–3%, according to BCA Research. The contribution-to-
growth figures reflect the long-term rut in which the nation’s
economy has been stuck.
©2011 Wilmington Trust Corporation. All rights reserved. 2
Beset by deflation, Japan’s nominal GDP
8%
declined for 18 straight years, 1992–2009
Peak in Japan’s
6%
share of global GDP:
12.2% in 1991
4%
Japan’s share of
2% global GDP:
8.7% in 2010
0%
–2%
–4%
–6%
1990 1993 1996 1999 2002 2005 2008
Rate of growth in nominal Japanese GDP
Figure 2 shows Japan’s largest trading partners. In some cases,
countries will need to find other sources of goods typically
imported from Japan. At the top of the list of Japanese exports
that may be in short supply for some weeks or months are
autos, auto parts, and semiconductors, especially memory
devices for personal computing devices. On the import
side, Japan will have to purchase larger quantities of oil as a
substitute for domestic nuclear power. Some of Japan’s trading
partners will be affected more than others. For example, while
Australia accounted for just 6.3% of the total value of Japanese
imports in 2009, those same goods and services represented
nearly 17% of Australia’s exports, according to Strategas
Research Partners. The economic growth of Australia is likely
to be disproportionately, if temporarily, affected by a downturn
in Japanese demand.
Global economic growth: A temporary dent is likely
The area struck by the earthquake and tsunami accounts
for 6–7% of Japan’s economic output, according to Barclays
Capital. The region is important globally for its manufacturing
of electronic components and there will likely be some supply
chain disruptions in a few industries as a result. The loss of
Investment COMMENTARY
March 17, 2011
Figure 2:
Japan’s main trading partners
Imports in 2009
¥, in trillions Share of all Japanese imports
China 11.436 22.2%
United States 5.512 10.7%
Australia 3.242 6.3%
Saudi Arabia 2.720 5.3%
United Arab Emirates 2.115 4.1%
Source: Japan’s Ministry of Internal Affairs and Communications
power as a result of rolling black-outs in Japan also has the
potential to cut production if not thoughtfully managed. We
expect the disasters may shave 0.1– 0.3% off of global growth
over the next few quarters, which we view as a negligible
impact. While the extent of the tragedy would worsen greatly
and global volatility would increase, we believe the impact on
global growth would only be slightly larger if there is a full-
scale meltdown of any of the affected nuclear reactors.
Inflation: Suddenly more worrisome
Nuclear power accounted for 13–14% of global energy
consumption in 2010, according to the World Nuclear
Association. Thus we are concerned about the potential
indirect impact of the sudden and severe global aversion to
the use of nuclear reactors for energy generation. In the wake
of the disasters in Japan, China has halted the permitting
process for new reactors. Germany has announced plans to
delay, perhaps permanently, a process used to extend the life of
older reactors. Germany does not have sufficient new nuclear
reactors in production to offset the capacity that will now be
lost as older nuclear plants are decommissioned. These are but
two examples. It seems reasonable to assume that the events
in Japan will reduce the number of new nuclear reactors built
globally for at least the next few years.
The decline in nuclear energy production will need to be
replaced by another source, or it may lead to declining global
growth. We believe the most likely outcome is an increased
reliance on fossil fuels like coal, oil, and natural gas in the near
term. Absent commensurate increases in supply, increased
demand for fossil fuels may well drive up their prices. At some
point, higher energy prices probably would have a trickledown
effect of increasing the prices of all sorts of goods and services.
©2011 Wilmington Trust Corporation. All rights reserved. 3
Exports in 2009
¥, in trillions Share of all Japanese exports
China 10.236 18.9%
United States 8.733 16.1%
South Korea 4.410 8.1%
Taiwan 3.399 6.3%
Hong Kong 2.975 5.5%
Bank of Japan: Ensuring liquidity
We believe the Bank of Japan has done a good job of ensuring
adequate liquidity in the nation’s banking and financial
systems. In the immediate aftermath of the quake, the central
bank emphasized that it would “provide ample funds sufficient
to meet demand in financial markets and do its utmost to
ensure financial market stability.” The bank announced a ¥5
trillion increase to an existing asset purchase program—and
a few days later, another ¥5 trillion increase—bringing the
overall size of the program to ¥45 trillion. Under the program,
the Bank of Japan buys Japanese government bonds, Treasury
bills, commercial paper, corporate bonds, equity exchange-
traded funds, and shares in real estate investment trusts. These
actions should be sufficient to enable the Japanese banking
system to function normally, which will allow most Japanese
corporations to continue to produce goods and services and
provide income, in the form of paychecks, to Japanese citizens.
Ample liquidity lowers the probability of global economic
contagion.
The Japanese equity market: Pummeled in the aftermath
In the first two days of trading after the earthquake and
tsunami, the Nikkei 225 Index plunged more than 16%,
exacerbating modest declines earlier in the week. It is not
surprising that panic selling occurred, especially in light of
the deteriorating conditions of nuclear reactors. Over the next
few days, as the severity of the disasters became clear outside
of Japan, stock prices worldwide generally declined, if only
modestly. Commodity prices, including those of natural gas,
oil, and gold, also fell. U.S. Treasury prices rose relatively
sharply, pushing their yields lower. Municipal bonds also
rallied, though not as hard as Treasuries. Corporate bonds have
Investment COMMENTARY
March 17, 2011
not kept pace with government issues. Interestingly, the yen has
strengthened, in part due to the expected repatriation of money
by Japanese savers.
On balance, the movements in asset prices since March 11
suggest that investors expect the global economy to slow
meaningfully in response to the calamity in Japan. Our view is
that investors may have overreacted, if only slightly.
Our clients’ exposure to Japanese equities
Most high-net-worth investors whose portfolios reflect our
asset allocation recommendations should have had, as of the
beginning of March, a modest 1–5% of their assets invested in
Japanese equities via diversified international equity vehicles.
Thus, a 10% decline in Japanese stocks would result in a
decline of 0.1–0.5% in the value of their portfolios. In practice,
performance effects would vary widely, owing to both the actual
extent of Japanese holdings and to performance differentials
between the international equity vehicle(s) in the account and
broad indices of the Japanese market. The strength in the yen
since March 11, and a corresponding decline in the U.S. dollar,
would have offset some of the declines Japanese equity investors
otherwise would have witnessed, assuming unhedged currency
exposures.
A recommended asset allocation policy change
On March 16, our Investment Strategy Team (IST)
recommended a Japanese crisis-related investment policy
change—the adoption of neutral allocations to growth and
value stocks in large-cap U.S. equity portfolios. Our previous
style mix in large-cap U.S. equity portfolio was 65% growth/
35% value. In recommending the shift, our IST cited the
possible depressing effect of the disasters on the technology
sector, which accounts for roughly 30% of large-cap U.S.
growth indices but less than 10% of large-cap U.S. value
indices. To be sure, this allocation change does not reduce in a
meaningful way the overall equity risks borne by our strategy-
following clients. This is appropriate given our belief that
investors may have overreacted, if only slightly, to the calamity
in Japan. The effects on global economic growth are likely to be
modestly detrimental in the short run but modestly stimulative
in the rebuilding phase. Our expectation of modest effects on
the global economy reflects Japan’s limited and declining share
of global economic activity.
©2011 Wilmington Trust Corporation. All rights reserved. 4
QH1572
Our outlook: The global economic recovery will continue
Despite the toll in terms of human life, we don’t believe the
events in Japan (or in the Middle East) change our main
investment thesis. Global growth remains on solid footing,
supported by loose fiscal and monetary policies—notably low
interest rates. If anything, the Japanese earthquake increases
the likelihood that more governments will need to increase
interest rates to combat inflation. We continue to see 2011 as
generally hospitable for investors, with accelerating global
growth and tame inflation in the developed world due to high
unemployment, affordable housing, and still-plentiful
economic capacity. Asset prices are supported by easy fiscal and
monetary policies in most major economies as well as by
increased lending, consumer credit, and spending. The third
year of a presidential term also has an excellent track record.
We are not nearly so sanguine about the prospects for 2012
as we believe fiscal and monetary policy will begin to tighten.
But we will, as always, follow our disciplined asset allocation
process, focusing on asset valuations, investor sentiment, and
the direction of the global economy.
The information in this Investment Commentary has been obtained
from sources believed to be reliable, but its accuracy and completeness are
not guaranteed. The opinions, estimates, and projections constitute the
judgment of Wilmington Trust and are subject to change without notice.
This Commentary is for information purposes only and is not intended
as an offer or solicitation for the sale of any financial product or service
or a recommendation or determination by Wilmington Trust that any
investment strategy is suitable for a specific investor. Investors should seek
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