Economic and Financial Impact of Tokyo Earthquake and Stock Market Sell-off

I rarely invite guest authors in, but the following piece is worth an exception. The author is Phil Diamond, CFA, Chief Investment Officer of Focus Point Solutions:

Before you all get the idea to ask the question, we thought we’d go ahead and answer it. What does this mean for our portfolios? The short answer is probably very little. Obviously, the outlook in Japan has changed in the last week. Much of Japan’s focus is going to shift from economic recovery and growth to helping their fellow Japanese ease their crisis.

The world’s reaction to this series of disasters has been overblown. Japan will have a time when they won’t be able to produce as much as they had produced. Part of this will be due to direct damage to facilities in the north where the earthquake and tsunami were focused. Part of this will be due to power shortages as most of Japan’s 55 nuclear power generators were taken off-line to check for damage. This second issue should right itself in days, the first may take months. But, Japan did not stop just because of the earthquake and tsunami. Most Japanese were not directly impacted by this disaster and will largely go about their business, perhaps even work a little harder if that can ease the suffering of their countrymen in the north.

Getting food, shelter and medical supplies to the stricken area is the first priority, but soon thoughts will turn to repairing and rebuilding this shattered area. That will create jobs and growth for the affected area.

Japan will need steel, cement, machinery and other materials to rebuild. These will largely be produced in Japan. There may be a slowing of exports as supply chains get interrupted, but that will get fixed and Japan will come back.

The gross overreaction of world markets and Japan’s market for that matter will soon be seen as just that, an overreaction. We did not value Japan’s stock market based on the assumption that there would be no earthquake and no tsunami. The idea is that looking forward, Japan’s stocks are worth their discounted future cash flows. Those cash flows have not been reduced by 20% in the last several days as Japan’s market has been. The market was probably a little pessimistic about Japan even before the disaster. Now, we are just too low in valuing many of Japan’s stocks.

The reaction of other world markets to Japan’s financial panic is just silly. What has made French consumer goods companies and English manufacturers worth less? Nothing. This is a reaction to perceived higher risk premiums by investors worldwide. We’ve been buffeted by the shock that disasters of this magnitude can happen in civilized places like Japan. If it can happen to them, it can happen to us. Well duh! Nothing is guaranteed, but the probability is that nothing like this will happen again for many, many years. This was a once in a century occurrence. We can’t live our lives and plan our futures and invest our money based on once in a century events.

The closest parallel to our mind was the reaction of the markets to the 9/11 attacks. The loss of life, the property damage, the impact on the broad economy were all far smaller from that event than from Japan’s current disaster. But, people reacted the same way. They panicked. What good did it do them? None. Within a couple of months the market had recovered all its losses from immediately after 9/11. Then we went on and completed our bear market, but the ultimate lows of the bear weren’t all that far below the lows hit the week after 9/11. If people stick with their plans and look at these types of events as opportunities rather than crises, they are better prepared to react correctly.

 As we have said before and will likely say again, “no one brags about selling on Black Monday.” But that is exactly what nearly everybody did. No one will be proud of selling Japan today. Few will look back at this moment and say they did the right thing.