Earthquake, Tsunami, Nuclear Crisis:
A Japanese Tragedy

Eric Stein, CFA
Senior Director, Investments

Most importantly, our thoughts go out to the residents of Japan as well as anyone who may have family or friends affected by the crisis. As we all know, the country was hit by a devastating earthquake, followed by a tsunami that literally destroyed everything in its path, which has now led to extreme challenges with nuclear power plants. This is obviously a disaster of tremendous and historic proportions that continues to unfold. The challenges that Japan faces in its rebuilding efforts are numerous.

"We just don’t know what is going to happen" is a common phrase heard among numerous experts quoted in the media. With these high levels of uncertainty we have witnessed tremendous drops in global equity markets. Specifically, the Nikkei 225 dropped 17.5% from March 10th to March 15th (Source: Nikkei). The drop in global equity markets is not terribly surprising as markets do not like uncertainty.

In the short term, economist consensus says that estimates for growth are lowered in the short term but actually increase for the 3rd and 4th quarters of the year as Japan’s massive rebuilding effort takes greater shape. There is ongoing debate about where the funding for this rebuilding will come from. One option is for Japan to sell some of their U.S. Treasury holdings (they are currently one of the largest holders). A mass selling of U.S. Treasury securities would lead to lower prices and higher yields. However, in the short term, the crisis in Japan has led to a flight to quality with rates on the 10 year Treasury falling from 3.5% on March 9th to 3.2% on March 16th (remember, prices rise when rates fall) (Source: U.S Treasury).

The events unfolding over the last week just add to the economic tug of war that was already taking place. We have had political uprising in the Middle East and North Africa (MENA) along with rising food and energy prices weighing on investors’ minds while at the same time we have had some positive economic momentum domestically. This has not been lost on the Federal Reserve who this week kept the Fed Funds rate at near-zero levels and continues to keep their options open as their bond buying program (QE2) is expected to end at the end of the second quarter of 2011.

In terms of investment implications, there are still many unknowns. What we do know is that Japan is the world’s 3rd largest economy and therefore has a substantial place in non-US benchmarks. For example, Japanese holdings represent a 22% stake in the MSCI EAFE index (Source: MSCI as of February 28, 2011). Therefore, investors should certainly expect to see depressed values in various non-US holdings.

What is an investor to do? Rather than acting emotionally and selling in panic mode, we again recommend focusing on the aspects that are more within your control; for example, your savings rate, investments costs, and your overall asset allocation. History tells us that investing emotionally and in a reactive manner has been shown to hurt investor returns. In fact, a recent article on Bloomberg.com discussed how U.S. stock investors who avoid “panic selling” are likely to be rewarded for their patience. Source: www.bloomberg.com

As always, please contact your wealth advisor if you have any additional questions.

Wealth Management Disclosure