Investors may have to brace themselves for some turmoil in the days and weeks ahead.
The Bank of Japan has promised to inject liquidity into the financial system to prevent a collapse. But the Tokyo stock market nonetheless plunged more than 4% shortly after opening Monday morning, three days after the devastating earthquake.
Many big Japanese investors – insurance companies, banks and other institutions, as well as private households – will need to sell some of their holdings quickly to raise cash.
Meanwhile, most potential buyers of stocks are likely to sit on their hands. Institutional investors fear uncertainty above all else. Few fund managers will brave the "career risk" of a bold bet on Japan at this juncture. And how many private investors are willing to brave the emotional challenge of investing in Tokyo today?
Meanwhile, the markets will be absorbing the economic news. It's likely to be grim.
Thousands, maybe tens of thousands, may be dead. Many more will be homeless. The country has been forced to launch "rolling blackouts" to cope with the loss of nuclear power. Infrastructure has been destroyed. And, as my Dow Jones colleagues Yoshio Takahashi and Hiroyuki Kachi wrote, the quake has hit a broad range of Japan's key industries. Honda, Toyota, Nissan, Sony, Panasonic and Toshiba have all shut factories temporarily in response to the disaster.
"When we talk about natural disasters, we tend to see an initial sharp drop in production... then you tend to have a V-shaped rebound," Michala Marcussen, head of global economics at Societe Generale, told Reuters. "But initially everyone underestimates the damage."
Yet how much should this really shave off the value of shares? The economy will recover, probably faster than many fear. And the economic events of the next few months, or even a year, are less important to the true value of the stock market than investors typically believe.
Research by Ben Inker, chief investment officer at fund firm GMO, found that most of the value of your shares is based on the profits companies are going to earn many years, even decades, into the future. Next quarter's earnings, even next year's earnings, don't matter anywhere near as much as we think.
Some people will point out that the Japanese market slumped by about a quarter in the months after the Kobe earthquake of 1995. And this earthquake was considerably worse.
But there's one big difference.
When the Kobe earthquake hit in 1995, the Japanese stock market was still coming down from the biggest equity bubble of all time. Shares were very expensive, which meant that they were highly vulnerable to any setbacks and there was a long way to fall. On the eve of that earthquake, the market in Tokyo traded on an absolutely absurd 53 times forecast earnings.
Today: Just 13 times.
Other historical analogies offer little guide. We remember that Wall Street plummeted in the immediate aftermath of 9/11. We sometimes forget that it quickly rebounded. Asian markets were able to shrug off the economic impact of the 2004 tsunami pretty quickly.
Even if the Japanese stock market is in for a rocky ride, what about markets here?
You may have to expect at least some effect on Wall Street and elsewhere. Capital markets are global. Japanese institutions liquidating investments to raise cash will be selling in New York and London as well as Tokyo. And some of the same factors will be keeping potential buyers on the sidelines. With all this uncertainty, investors are more likely to want to steer clear. It's human nature.
But how far this earthquake will affect the actual economy of the rest of the world is much harder to gauge. Yes, Japan is the world's third largest economy and a major trading partner. But it doesn't matter quite as much as some may think.
Japan today accounts for a smaller share of the global economy than at any time since the 1970s – 5.8%, according to the International Monetary Fund, compared to 7.5% a decade ago and more than 9% in the early 1990s.
We send just 7% of our exported goods and services to Japan, according to the U.S. Department of Commerce. That's far less than we send to Canada or Mexico, and one-fifth as much as we send to the European Union. The entirety of American exports to Japan account for less than 1% of the total U.S. economy.
Japan's stock market, which twenty years ago was the most valuable in the world, today accounts for a smaller share of global equity values than at any time in decades. On the eve of the Kobe earthquake, it accounted for nearly 30% of world stock market values. Today? Just 7.5%.
For investors, the bigger risk is that, today, world stock markets are already pretty expensive. As we know, that leaves them vulnerable to external shocks or a downturn. Whether Japan sparks one is another matter.
Update, March 13, 11:16 p.m.: This story was updated to reflect the opening of the Tokyo stock market.
The Bank of Japan has promised to inject liquidity into the financial system to prevent a collapse. But the Tokyo stock market nonetheless plunged more than 4% shortly after opening Monday morning, three days after the devastating earthquake.
Many big Japanese investors – insurance companies, banks and other institutions, as well as private households – will need to sell some of their holdings quickly to raise cash.
Meanwhile, most potential buyers of stocks are likely to sit on their hands. Institutional investors fear uncertainty above all else. Few fund managers will brave the "career risk" of a bold bet on Japan at this juncture. And how many private investors are willing to brave the emotional challenge of investing in Tokyo today?Meanwhile, the markets will be absorbing the economic news. It's likely to be grim.
Thousands, maybe tens of thousands, may be dead. Many more will be homeless. The country has been forced to launch "rolling blackouts" to cope with the loss of nuclear power. Infrastructure has been destroyed. And, as my Dow Jones colleagues Yoshio Takahashi and Hiroyuki Kachi wrote, the quake has hit a broad range of Japan's key industries. Honda, Toyota, Nissan, Sony, Panasonic and Toshiba have all shut factories temporarily in response to the disaster.
"When we talk about natural disasters, we tend to see an initial sharp drop in production... then you tend to have a V-shaped rebound," Michala Marcussen, head of global economics at Societe Generale, told Reuters. "But initially everyone underestimates the damage."
Yet how much should this really shave off the value of shares? The economy will recover, probably faster than many fear. And the economic events of the next few months, or even a year, are less important to the true value of the stock market than investors typically believe.
Research by Ben Inker, chief investment officer at fund firm GMO, found that most of the value of your shares is based on the profits companies are going to earn many years, even decades, into the future. Next quarter's earnings, even next year's earnings, don't matter anywhere near as much as we think.
Some people will point out that the Japanese market slumped by about a quarter in the months after the Kobe earthquake of 1995. And this earthquake was considerably worse.
But there's one big difference.
When the Kobe earthquake hit in 1995, the Japanese stock market was still coming down from the biggest equity bubble of all time. Shares were very expensive, which meant that they were highly vulnerable to any setbacks and there was a long way to fall. On the eve of that earthquake, the market in Tokyo traded on an absolutely absurd 53 times forecast earnings.
Today: Just 13 times.
Other historical analogies offer little guide. We remember that Wall Street plummeted in the immediate aftermath of 9/11. We sometimes forget that it quickly rebounded. Asian markets were able to shrug off the economic impact of the 2004 tsunami pretty quickly.
Even if the Japanese stock market is in for a rocky ride, what about markets here?
You may have to expect at least some effect on Wall Street and elsewhere. Capital markets are global. Japanese institutions liquidating investments to raise cash will be selling in New York and London as well as Tokyo. And some of the same factors will be keeping potential buyers on the sidelines. With all this uncertainty, investors are more likely to want to steer clear. It's human nature.
But how far this earthquake will affect the actual economy of the rest of the world is much harder to gauge. Yes, Japan is the world's third largest economy and a major trading partner. But it doesn't matter quite as much as some may think.
Japan today accounts for a smaller share of the global economy than at any time since the 1970s – 5.8%, according to the International Monetary Fund, compared to 7.5% a decade ago and more than 9% in the early 1990s.
We send just 7% of our exported goods and services to Japan, according to the U.S. Department of Commerce. That's far less than we send to Canada or Mexico, and one-fifth as much as we send to the European Union. The entirety of American exports to Japan account for less than 1% of the total U.S. economy.
Japan's stock market, which twenty years ago was the most valuable in the world, today accounts for a smaller share of global equity values than at any time in decades. On the eve of the Kobe earthquake, it accounted for nearly 30% of world stock market values. Today? Just 7.5%.
For investors, the bigger risk is that, today, world stock markets are already pretty expensive. As we know, that leaves them vulnerable to external shocks or a downturn. Whether Japan sparks one is another matter.
Update, March 13, 11:16 p.m.: This story was updated to reflect the opening of the Tokyo stock market.
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