Major market indices were lower last week. The DJIA lost 1.54%, the S&P 500 dropped 1.92%, and the Nasdaq fell 2.65%. Value stocks outperformed growth stocks. And the small cap index lost 1.02%. The 10-Treasury yield closed 14 basis points lower at 3.27%.
Last week proved a battleground. It tested the resolve of bulls and bears. While markets declined, the intraday carnage portended a downside much worse than that with which we ended up. Volatility soared, with VIX up 20%. Following Japan's disaster, panic reigned.
Meanwhile, developments outside of Japan also pressured investors. The recent decline in crude oil prices was snapped when Saudi troops cracked down on protesters in Bahrain. Moody's didn't help when it cut Portugal's sovereign debt rating by two notches to A3 with a negative outlook.
So what are the economic and market implications?
Japan's economy is virtually shut down amid logistical problems, a fall in demand, and the mental and physical disruption and displacement of hundreds of thousands of workers. Japanese GDP will take a big hit. Possibly fall back into recession.
It took six months for the Japanese markets to recover from the Kobe earthquake in 1995, which was 100x less powerful on the Richter scale. The Nikkei 225 has already fallen as much as it did in 1995, around 25%, but that doesn't really mean anything. These types of wounds take a long time to heal, and it's not yet clear how great the injury is.
The next big theme will be the impact on the global nuclear industry. Proponents will say that it is safe. Japan was an anomaly. That will be a difficult sell.
Still, the world will continue to need energy. The most likely benefactors will be natural gas, crude and coal. From a regional perspective, the biggest beneficiary may be Russia, which has large quantities of coal and natural gas.
We also like the trajectory of the oilfield service providers, at times like these. They will be stretched to maximize production and meet demand. Their revenues should reflect that.
Energy stocks were leaders in the 1Q advance. They fell less than other groups after the earthquake. They are in demand again now. They are also cheap, and positioned to gain as more carbon energy is required to supplant the diminished demand for nuclear energy.
Further, we think energy stocks will continue to enjoy geopolitical tailwinds.
Unrest in Bahrain, Yemen, Saudi Arabia, Syria, and an outright civil war in Libya will all support higher energy prices and bolster the sector. While demand may diminish in China, something will have to replace Japan's nuclear power. That will likely be a couple-hundred thousand barrels of crude oil per day. Rising prices and a global recovery will add further support. We own a number of strategic positions in this area and will look for continued momentum.
Finally, given the current reality, the question should be asked: does the Japanese situation present investors with a buying opportunity?
The Japanese markets have long fared so poorly so as to prevent a contingency of institutional enthusiasm for Japanese equities. Counter intuitively, that is good. Unlike the '95 Kobe earthquake, there will not likely be a protracted period of selling. There simply are not enough current owners to drive a long-term sell off.
Next, one has to ask if this event brings negative, long-term ramifications for global equity markets. In our opinion, the answer is likely no. While there will obviously be ramifications, and one frets over the loss of human life. But the Japanese government is acting quickly to inject capital into needed areas and rebuild infrastructure.
At this point, the situation does not appear to present massive supply chain interruptions, nor to be something outside of the realm of repair.
Goldman Sachs estimates that the total cost of damage from the March 11 earthquake will be $198 billion. That's roughly 1.6 times that of the '95 Kobe earthquake, equaling roughly 4 percent of GDP.
Martin Wolf of the Financial Times points out that as of March 17, Japan has lost $344 billion worth of market value, equaling nearly 7 percent of the country's GDP. Which leads to our final point-valuation.
At a point when global equity markets were beginning to appear a bit pricey, less attractive, Japanese stocks are cheap. They are, in fact, at their cheapest levels in 20 years. The Nikkei could continue to fall. However, based on today's valuations, we don't think it could fall much further. And if it does, then it's likely overshot the mark-which markets are oft inclined to do during times like these.
Periods of high volatility and uncertainty have traditionally presented buying opportunities for those with the mettle to pull the trigger. We're not talking about blind speculation. But about calculated, well-calibrated risk taking when everyone else is heading for the exits. These inflection points have always presented maximum opportunity to those suited for the ride.
Sir John Templeton said, "The best time to buy is at the point of maximum pessimism." For investors willing to risk much, willing to grit their teeth and buy in the face of widespread panic, that time may be now.
That said, this story continues to unfold.
We think there continues to be excellent opportunities at home. We do not recommend the purchase of Japanese stocks. Not yet, at least. Stay tuned...