Markets' Reaction to Japan

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Markets' Reaction to Japan's Nuclear Situation

The natural disasters that hit Japan on March 11, 2011, are truly a tragedy. Everyone is watching the devastating news and images emerge as Japan works to provide aid and relief to its people. The safety of their citizens and aid workers is, and should be, the top priority as the loss of life and ongoing recovery challenges are immense.

Almost anytime there is a natural disaster, however, there is also a market and economic impact. We've seen this play out as Japanese stocks have fallen dramatically. U.S. and European stock markets declined in sympathy and are now down more than 5% from their recent highs. Investors may be wondering about the future impact, but it's too soon to tell, since no one knows whether Japan’s damaged nuclear plants can be controlled safely or when overall electrical power can be restored to the country. However, we expect several effects:

Brief stock market impact – The stock market impact is likely to be brief, as stocks usually react immediately to uncertainty and devastation. Worries about the damaged nuclear plants and their broader economic impact could continue to be negative for stocks until the nuclear plants are stabilized. Stock market sell-offs in response to crisis events tend to be short term because recovery and rebuilding efforts tend to follow rapidly. Historically, stock markets often return to their pre-disaster levels about a month after these events occur.(1)

Appropriate policy response – The Bank of Japan has acted quickly to increase the cash in the financial system to help ensure money is available and to help stabilize the markets. Despite high deficits, the Japanese government will increase spending to assist people in need and to rebuild.

Slower growth for Japanese economy – Japan's economy was in recession and declined at an annual rate of 1.3% in the fourth quarter of 2010. Even if the nuclear plants can be controlled safely, the Japanese economy will likely fall into negative territory in the first quarter. Many companies have stopped production, but until power can be restored, it's not possible to estimate the overall impact. Almost immediately, though, rebuilding will begin, and that's a powerful stimulus for economic growth later in the year. The Japanese economy was expected to grow 1.5% in 2011, but it will undoubtedly be at least a little weaker.(2)

Global economy still stable – Japan is the third-largest country measured by gross domestic product (GDP), but its economy wasn't expected to grow much in 2011. Japan's oil consumption is expected to be lower, causing oil prices to drop in response. And the Saudi Arabian protest planned for last Friday did not cause any concerns for that government. Lower oil prices are a positive for the rest of the world. In addition, Europe has expanded its rescue fund, which reduced the risks of European debt.

No one could have anticipated the largest earthquake in Japan's history, and our thoughts are certainly with everyone impacted by this tragedy. But remember, it's not a reason to alter a long-term investment strategy. Sharp stock market declines are distressing, but they end as unexpectedly as they begin. Selling into a market panic is not an appropriate response. Staying invested, focusing on quality and owning a well-diversified portfolio of investments can help investors weather unexpected global events and achieve their financial goals.

For more information read our report "Crisis Events and the Dow." (pdf)

Kate Warne, Ph.D, CFA
Investment Strategist
Sources:
(1) Ned Davis Research. Further distribution prohibited without prior permission. Copyright 2011 (c) Ned Davis Research, Inc. All rights reserved.
(2) Bloomberg; Consensus estimate for real gross domestic product growth.


Also, check out Historical Market Reaction to Crisis.