The Market's Disaster Drill

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

By Bill Saporito Monday, Mar. 28, 2011
    • Source: Biranyi Associates

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    Investors often head for the exits when disaster arrives, but not necessarily out of fear. "There's no reason to believe that what we are seeing is overreaction. In a perfectly rational world, investors would pull back from risky situations," says Lubos Pastor, a professor of finance and a specialist in market behavior at the University of Chicago's Booth School of Business. It's hardly a perfectly rational world (that's why we have bubbles), but the earthquake increased uncertainty, which increased volatility, which then demanded lower asset prices as compensation. The value of your portfolio postquake may be lower, but at least it promises a greater return in the future. That's the whole point. "If you take the bottom of the financial crisis, November 2008 or March 2009," says Pastor, "the return was low, but the expectation of reward was high." And that expectation was rewarded when the market took off on a two-year tear.

    It's possible that the Japan earthquake got investors to focus again, and they may not like what they're seeing. The event comes at a time when the global recovery is still not assured. Rising oil prices tied to the ongoing crisis in the Middle East — remember that? — are threatening the U.S. economy with $5 per gal. ($1.32 per L) gasoline. More ominously, rising energy prices threaten the loss of as many as 600,000 jobs, because companies could shed labor to offset increased costs. Ironically, the oil threat has receded: since the quake, the price of oil has slid to $100 per barrel, as Japan's decreasing economic activity will cut demand.

    Consider too that had this disaster occurred a year ago, it would have struck the world's second largest economy. Instead, it has struck the third largest. Japan has been mired for two decades; its share of the world GDP has declined by half since the mid-1990s. Last year, China displaced Japan as No. 2. The damage to the global economy is commensurately smaller. The world can absorb it far more easily than Japan can. Investors will figure that out soon.

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