Yes, you read that correctly. Japanese stock markets are down 14% and have in 2 days experience more than half a trillion dollars in wealth destruction. There are separate conversations to be had…
First, there is the human tragedy. On top of losing homes, jobs, schools, etc. in terms of infrastructure, millions are left stranded without water and electricity. To really top it off, now millions will lose invested wealth and face an investors worst-case scenario – permanent loss of capital. No amount of standard deviations does that type of risk justice on the human level.
Second, and a distant second at that, is the conversation about the investment implications. I have viewed Japanese companies as undervalued on their own after being down roughly 75% from their peak in the late 1980′s. On top of that, they are facing favorable headwinds with a relatively strong currency (relative to their tax base, demographics, etc.). So a currency hedged investor should do well in the long term. I continue to view those shares as an opportunity and will look for selective entry points to add exposure.
Lastly for tonight, there are the additional implications felt globally. Nuclear energy firms, a portion of my energy overweight, are under significant stress, while on the flip side, my exposure to natural gas has benefited. Overall, I am maintaining my exposure to energy and will look to gain exposure to specific uranium related companies in the next few days and weeks.
The US equity futures, on the other hand, are pointing to a significant gap down tomorrow morning, and assuming they don’t rally may provide a bounce for the active trader. However, I am short the US indexes, and will not be covering. I will not add to the position here, but my valuation metrics continue to point to increased P/E compression. In a scenario where we face a worldwide economic slowdown, coupled with relatively high energy costs and continued margin compression, inflation fear mongers will look silly. Deflationary pressures continue to be the main risk, and in that scenario, we will first have significant margin and valuation compression, and then will actually bottom on high P/E (low q-ratios). The reason for this counter-intuitive statement is that in a deflationary environment, the E goes down, and for a while the P goes down fast. Eventually, the P stabilizes, while the E continues to go down. In that scenario, P/E will no longer be a good valuation measure, and investors must focus on q-ratios to understand replacement cost, return on assets, and the setup for the eventual price stability and upticks in inflation.
We have years for that to happen. I am not a buyer on the dips.
Relevant ETFs: DXJ, FXY, NLR, RWM, SH, SPY, IWM