It may seem strange to be discussing the anatomy of a panic in a month where we made money, but March offered us an insight into the behavior of markets during periods of high uncertainty.
The March 11 earthquake hit Japan with 15 minutes left in the trading day. An otherwise uneventful Friday at the Tokyo Stock Exchange ended with a 1.7% decline after the earthquake was felt. Over the course of the weekend, as more details emerged and the extent of the damage became apparent and the fear of a nuclear accident set in, a number of investors around the world decided to ‘sell Japan’.
On Monday morning, the Nikkei opened 2% lower and then fell another 4% over the course of the day. By the close of business on Tuesday, investors had driven the value of the third largest stock exchange in the world down by 16% over two days.
Was this a rational thing to do? Or was it a panic? We concluded that it was a panic – and thus would be reversed in short order. The panic diagnosis was arrived not by looking at Japan, but in looking at the activity in other markets.
A news event that was pushed off the front page by the situation in Japan was the March 14 decision by Saudi Arabia to send troops to Bahrain to help put down a civilian protest movement. There is an ethno-religous element to the Bahraini situation (not to mention it is the home of the US 5th Fleet) – the majority of the population are Shia-Muslims (the main religion of Iran) whereas the ruling elite are Sunni Muslims (the main religion of Saudi Arabia). So, on the day that Saudi troops put down a Shia-led demonstration within a few miles of US Naval Forces Central Command in the middle of the oil-rich Persian Gulf, the price of oil....fell. By 3%.
Gold fell; silver fell; even the price of rice fell.
One can almost imagine the instructions brokers received:
Client: “Get me out”.
Broker: “Of what?”
By the end of the month, the Nikkei had rallied. Not surprisingly, the selling turned out to be overdone. The panic sellers are quickly followed by the opportunistic buyers.
The bottom line is this – stocks have value because companies make profits. In the long run, the price of a stock is equal to the present value of its future cashflows. Whenever and wherever the next catastrophe occurs, the question to ask before selling is, ‘What does this mean for future corporate profits?’
As we saw with Hurricane Katrina, natural disasters which lead to construction activity boost the economy, jobs and profits. Sadly, in the case of Japan, it means billions in sales for builders of infrastructure and housing stock.