Tuesday, December 11, 2012

The Worst Outcome for Fukushima Is Priced Into Japanese Equities

There is no doubt the crisis at the Fukushima power plant is serious. I guess just about everyone on the planet has been made fully aware of just what is going on and what could happen. I am not going to add much value by talking about the crisis itself as this topic has been flogged to death by the press, analysts, and bloggers alike. What I might add that is of value to the average trader is the degree to which the crisis has already been factored into stock prices in the US and Japan.

Analysts typically fall into a technical or fundamental camp. Both these schools of thought have their merits during times when the market is behaving rationally or at least during times when there is no panic in the air. However, during times of extreme volatility, looking at the behavior of a chart with support and resistance lines or looking at fundamental valuations will not help you too much to understand just what is being priced into the market, and by default, the degree to which the market is oversold.

I think one of the best ways to identify the degree to which a market is oversold is to look at the behavior of the crowd outside of financial markets, i.e. human behavior in general. Specifically, we are looking for extremes in behavior, or at least behavior that is radically out of the ordinary. Given that stock prices are merely reflections of the confidence of the crowd, it stands to reason that if we see extreme behavioral patterns in the crowd, then by default we could assume that whatever caused the market to sell-off in the first place has been fully priced in.

Today I came across an interesting article in MailOnline. Note the main points of the article:

  • The U.S. Surgeon General warns Americans to 'be prepared' for harmful radiation from Japan to hit West Coast.

  • Nukepills.com sells 250,000 potassium iodide pills while Anbex gets three orders a MINUTE instead of per week.

  • Packs of 14 pills that usually cost $9.99 changing hands on Amazon.com (AMZN) and eBay (EBAY) for $250 to $400.

  • Geigercounters.com begs people not to place any more orders after it sells out of radiation detection gadgets.

  • A surge in purchases of gas masks and emergency survival kits including food, water and space blankets also reported.

  • A real-time radiation map of U.S. shows levels are currently within normal ranges.

I went to a military store's website, and sure enough, look at what was offered for sale on the landing page:

What is the significance of all of this? Well, if there is an unprecedented demand for gas masks, chemical suits, anti-radiation suits and pills by people almost half-way across the globe from where the catastrophe is taking place, then it is a fair bet that the very worst outcome has already been anticipated by the crowd (like a repeat of Chernobyl), and that it has been factored into the prices of equity markets.

Now, if the crisis at Fukushima does not turn out even half as bad as Chernobyl (there is already a growing body of evidence that suggests it is practically impossible for Fukushima to become another Chernobyl), then the next material move in equity markets is likely to be to the upside. It certainly helps that the fundamental valuations of Japanese equity markets are more or less at record low levels, and that even before the nuclear crisis, Japanese equities were not exactly the flavor of the month with investors.

There is something that I have not discussed before which makes Japanese equities considerably more attractive than before the crisis. In four days, the Japanese equity market fell by more than the US equity market did in the crash of 1987 (yes, the 2nd section of the TSE and the JASDAQ fell by some 30% in four days). Any investor that had a remotely weak hand has been knocked out of the Japanese equity market which means that there are far less individual holders of Japanese equities now than there were just a few weeks ago. One always has to ask where the marginal seller is going to come from. Quite frankly, I don't know where the marginal seller is going to come from to drive prices lower.

Long term bull markets begin when valuations are at extreme low levels, where everyone has written off the prospects for that market, and where there are lots of marginal buyers. It would seem that the stars are aligned for a sustained bull market to get into gear for Japanese equities.

Disclosure: I am long EWJ, JOF.

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