It would be indecent to begin any discussion of the Sendai earthquake without referring to the horrific human toll. Japan is a wealthy country that is uniquely prepared to deal with natural disasters, and the Japanese are extremely resilient people, but the scale of the calamity is without precedent. As someone who has lived in Japan and who has friends there, I strongly urge readers to donate to the relief effort. If you want to find out how to do this effectively, this article highlights several reputable organizations.
With that said, here are three points on the economic and financial consequences of this disaster:
The aggregate impact on the global economy and Japan's is likely to be small
You may have heard that the world's No.1 car company, Toyota (NYSE: TM), has halted production. Japan's role in global supply chains has had a knock on impact on industrial giants outside Japan, too. General Motors (NYSE: GM) has stopped work at two plants in Europe and is considering a stoppage at a Korean factory. In a global economy, the ripples from this disaster know no borders, but it's important to keep things in perspective.
Yes, the economic impact on the region around Sendai, which was hit hardest, will be enormous; however, that region represents less than 4% of Japan's GDP. The Carnegie Endowment for International Peace estimates that "Japan's growth will be slower for a quarter or two... A year from now, the change in GDP level from its pre-earthquake will likely be minimal." Japanese equities already looked pretty cheap before the event; they look only more so now. The iShares MSCI Japan Index ETF (NYSE: EWJ) is certainly worth a look (to add it to your watchlist, click here).
Don't let the market's reaction (short-term) drive investment decisions (long-term)
Many of the short-term market reactions to the disaster we are witnessing now are either wrongheaded or grossly exaggerated. For evidence of the overreaction, you just need to consider General Electric (NYSE: GE), which operates its nuclear activity as a joint venture with Japan's Hitachi.
With $1 billion of revenue, the activity contributes less than 1% of the conglomerate's total revenues. Despite this, the market shaved 7% off GE's market value during the first three days of last week, roughly twice the decline in the S&P 500. That underperformance represents an incremental loss of $7 billion in GE's market value; at 7 times the unit's annual revenue, that would be a hefty penalty even if that business were to disappear altogether.
More broadly, there are 65 nuclear plants under construction around the world today. Three countries -- Russia, India and China -- house two-thirds of that number. Given the nature of their governments (China and Russia) and/or their ravenous hunger for energy (India and China), I don't expect current events to have any adverse repercussions on these projects. Nevertheless, at last week's low price, shares of Cameco (NYSE: CCJ), one of the world's largest uranium producers, had lost a quarter of their value with respect to the previous Friday's closing price.
The longer-term impact is unpredictable and adds to general uncertainty
After an initial hiccup, the U.S. market appears to have regained its composure. But there are signs that investors are more skittish than before; that is, if the VIX index -- the market's "fear gauge" -- is anything to go by. Last week, the VIX index spiked almost 50% at one point, while the iPath S&P 500 VIX Short-Term Futures ETN (NYSE: VXX), which provides invidual investors with exposure to that index, gained almost 20% at its height. I have said that the U.S. market is due for a correction, and Black Swans (unanticipated events with big consequences) make excellent catalysts when sentiment is fragile and uncertainty is high.
There are plenty of other areas that could feel the aftershocks of this earthquake, including energy markets. Japan is the world's third largest economy, it's far from energy independent, and it depends heavily on nuclear power for electricity generation.
In the case of oil, the Japanese situation could add to the effect of political instability and push a tight market higher still. For natural gas, it could be a catalyst that reverses sentiment in a market that has been in the doldrums for some time. Either way, investors who own US Oil Fund (NYSE: USO) or the United States Natural Gas Fund (NYSE: UNG) or similar products should probably expect increased volatility (UNG gained nearly 7% last week).
Survival tips for investors
When investors come across a Black Swan, we can expect to witness confusion and irrationality at work. Investors are best off not reacting rashly to this (or any other) event. My advice is to seek out intelligent, well-sourced analyses and maintain a long-term perspective with regard to your portfolio. Finally, I don't think it is immoral to consider that events such as these can present investors with opportunity. Investors must make their own decisions, but if you want to help Japan, the best way is to donate money to relief; not investing in Japanese (or any other) stocks does nothing to alleviate the hardship and suffering of those who have been affected.
To track the shares mentioned in this article, click on General Electric, Cameco, US Oil Fund and United States Natural Gas Fund to add them to your watchlist, or start a new watchlist and add any company you want. You'll get valuable updates as well as immediate access to a new special report, "6 Stocks to Watch from David and Tom Gardner." Click here to get started.
