Tragedy in Japan

The devastating earthquake and subsequent tsunami that struck Japan last week, along with the ongoing nuclear power plant concerns, have caused panic selling in Japan’s stock market and a significant disruption in Japanese economic activity. A broad decline in global stocks has followed as the long-term economic impact of the crisis remains unclear.

An initial sell-off in the aftermath of a natural disaster is a common historical pattern in stock markets, as uncertainty causes some short-term selling while investors re-assess the outlook. As the world’s third-largest economy, lost output in Japan and disruption to industrial production will undoubtedly have a negative near-term impact on the global economy.

However, Japan was not considered to be a major driver of the 2011 expectations for a solid year of global growth. As a result, the fallout from the Japanese disaster may not in itself be enough to derail the global recovery; however, as an additional source of uncertainty for world financial markets to digest, increased volatility is to be expected in the near-term.

Any market can experience financial and economic crises as well as natural or man-made disasters. As with recent political unrest in the Middle East and northern Africa, the crisis in Japan underscores the value of portfolio diversification—across market sectors, asset classes, and countries. Japan, for example, represents just over 5% of the equity allocation in a typical Truepoint client portfolio.

It’s important to keep in mind that stock markets historically have recovered rather quickly from political crises and natural disasters. Markets plunged immediately after our own 9/11 terrorist attack, only to fully recover within two months. A study by Ned Davis Research of 28 political and economic crises since the Fall of France in 1940 found that in most cases the Dow Jones Industrial Average was higher six months later.

This is not meant to minimize the obvious humanitarian concerns resulting from the Japanese earthquake and the threat from the ongoing nuclear situation. The Japanese people have suffered an incredible catastrophe and untold thousands continue to deal with a lack of food, water and shelter. The ultimate death toll probably will not be known for many weeks.

With events unfolding rapidly, it’s too early to estimate the long-range implications for Japan. However, it is a rich and resilient country that has recovered before from devastating earthquakes, nuclear attack and world war.