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Japan’s black swan

It is natural for markets to overreact to catastrophic events

Discussing investment matters in relation to the events in Japan is difficult as our thoughts are with those who have suffered from the disaster. However, it is our job to assess the risks to our investment strategies and client portfolios.

Japan’s markets fell by 20 per cent after the tsunami and have since rebounded 5 per cent.

Japan is a big exporter and this area of the economy has suffered through the massive power outages and safety concerns that halted production. The area worst affected is not a major industrial area, however, and life outside of the region is gradually getting back to normal.

The stockmarket looked relatively cheap before the crisis and the falls seem overdone. The Bank of Japan reacted quickly to the crisis by injecting around ¥20trn into the financial system through the money market, asset purchases and bond buybacks.

The market is expecting a large repatriation of money from the world back into Japan, which will boost the currency valuation in the short term, possibly for six months.

Stockmarkets are assuming Japanese companies will foot the bill and domestic firms will remain hard hit. Defensive sectors in particular, such as railways and utilities, have seen their infrastructures destroyed.

For Japan’s multinationals, the temporary closure and lesser operating capacity of their domestic plants can be offset by sourcing from across global operations.

The cost of rebuilding public infrastructure will add to the debt burden, further under-mining the currency and making more rating agency downgrades likely.

Global stockmarkets have fallen on fears there will be a nuclear catastrophe, even though it looks unlikely. This demonstrates the inability of markets to price in rare high-risk events, known as black swans, where fear overwhelms rational behaviour.

Japan plays an important role in world trade as the third-biggest economy and a big importer and exporter. It has a strong manufacturing base that is likely to be interrupted but many Japanese companies are highly efficient and there is enough slack in the system to ensure supply of goods is not significantly interrupted. The country will recover and the effect on world gross domestic product is likely to be minimal.

The nuclear incident has had an impact on renewable resource stocks in the UK, driving up the share prices as countries review their nuclear fuel strategies.
We remain positive on Japan because of its internationally focused companies. Markets tend to overreact in the face of lack of information and volatility might be around for some time.

Adrian Lowcock is senior investment adviser at Bestinvest


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There is one comment at the moment, we would love to hear your opinion too.

  1. Investment markets always over-react to everything ~ look what happened in 2008 (massive sell-offs) and then in 2009 (a huge rebound, in most sectors greater than the falls of the preceding year). So when I read of huge falls, I take little notice and I tell all my clients to do the same.

    So keep on feeding in your investment contributions on a monthly basis and, over the medium to long term, you’ll ride out all the short term fluctuations caused by traders running around like headless chickens whenever there’s a bit of bad news or a word out of place uttered by someone influential.

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