The Market's Disaster Drill

The sell-off after the Japan quake is logical, painful--and destined to be a nonevent

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Source: Biranyi Associates

Markets can be merciless, bloodlessly processing available information to price assets appropriately. In the aftermath of Japan's triple disaster — an incomprehensible 9.0 earthquake, an incredible tsunami that killed thousands and the resulting damage at the Fukushima Daiichi nuclear works — its stock market fell more than 14% before regaining some ground on March 16. A massive loss of wealth attended a grievous loss of life.

With Japan facing short-term damage to its economy, all Japan-related assets have been written down. Fidelity's Japan fund, for instance, tumbled 7%. The economic recovery had already been losing momentum.

Japan's GDP contracted in the final quarter of 2010. The blow from the quake threatens to toss the country back into recession — or shave perhaps 0.5% from GDP growth, according to Bank of America Merrill Lynch. Some of Japan's power-short, logistics-constrained industries have had to shut down temporarily.

As the Fukushima Daiichi disaster worsened, the world's stock markets fell in anticipation of the wider economic consequences. The price of companies attached to the nuclear industry suffered damage, including Shaw Group, a nuclear-engineering specialist, which dropped more than 14% amid investor fears that the industry renaissance that had been taking place in an energy-hungry world would re-enter its post — Three Mile Island dark age. So did the price of insurers and reinsurers like Swiss Re, companies designed to take exposure to catastrophic losses. "Japan is dealing with a real situation, and the rest of the world is placing a risk premium on any assets related to it," says Milton Ezrati, Lord Abbett's senior economist and a Japan expert.

Ezrati was reluctant, understandably so, to verbalize another point. "You hesitate to call it—" he hesitated. Let's not: Japan's disaster will certainly create a buying opportunity. Some even see it as a catalyst for the country to finally deal with its economic ennui, leading to a growth spurt in 2012.

Destruction on such a massive scale, while locally chaotic and disruptive, generally doesn't have a lasting effect on global order. In the first week after the Sept. 11 terrorist attacks, the S&P 500 fell more than 5%. But within six months the index had gained it all back and then some. Three Mile Island, the charter nuclear disaster, was a nonevent in the market. Chernobyl's 3% first-week loss was short-lived, unlike the damage, which will last hundreds of years at the source. On a completely different scale, the Indian Ocean earthquake and tsunami of 2004 killed 230,000 people, a staggering human toll, which the market all but ignored because lots of poor people died.

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