A Look at Japan’s Stock Market Crash and Rally Post-Kobe Earthquake in 1995

A Look at Japan’s Stock Market Crash and Rally Post-Kobe Earthquake in 1995

Last night my pal and reader Jonathan Lederer sent out a great comparison piece to his clients, harkening back to Japan’s last major earthquake in 1995.  I asked Jon if we could republish here on the blog, and he graciously said it was cool to do so.

And to his credit, this piece dropped in my email inbox around 9:30pm last night – before today’s massive rally!


A Perspective on the Japanese Earthquake

by Jonathan Lederer, President, Lederer Private Wealth Management

Last week’s Tohuku earthquake and its tragic aftermath have triggered a relatively sizable selloff in the equity markets. Images of the devastation, along with ongoing uncertainty regarding a nuclear meltdown, have spurred many investors (a number of who were already nervous about the Middle East uprisings and European sovereign debt problems) to sell riskier assets. As a result, the major global equity indexes have fallen between 5-10% since last Friday’s earthquake, and the Japanese stock markets have declined by nearly 20% during this same time frame.

I believe it’s critical to maintain investment perspective during these times of turmoil. Although the recent tragedy may be unprecedented in scale, there are a number of similarities between the Tohuku earthquake and the quake that struck the Japanese city of Kobe back in January 1995. Following the Kobe earthquake, the Japanese economy experienced a very short-term setback before rebounding sharply due to the substantial rebuilding efforts.

The Nikkei 225 stock index, which was priced above 19,000 prior to the Kobe earthquake, fell nearly 25% by mid-1995. However, as the economy rebounded, Japanese stocks erased all of their post-earthquake losses by early December 1995 (see chart below). Last Friday, the Nikkei 225 opened at 10,607 (nearly 50% below where it traded back in early 1995). One week later, the index sits roughly 20% below where it traded before the Tohuku earthquake.

Japan stock market post-Kobe earthquake 1995(Click to enlarge)

I think that the Japanese markets are likely to exhibit a similar pattern this time around. While recent events will no doubt slow Japanese economic output, the slowdown is likely to be short-lived due to the tremendous rebuilding that will need to get underway once the crisis settles.

Considering that Japanese stocks late last fall were trading at book value (similar to where U.S. stocks traded in 1982 at the start of an impressive 18-year bull market), I would argue the recent pullback has created an even more compelling buying opportunity in Japan. Renowned global hedge fund manager Marc Faber has even gone as far as saying that the Japanese stock market decline has created a “lifetime buying opportunity” – meaning investors may seldom witness such attractive valuations in their lifetimes.

Of course, it’s important to also take into account the differences between the Japanese economy now versus then. First and foremost, government debt levels have increased substantially since 1995, while economic output has remained stagnant. In the process, net debt-to-GDP ratios have risen from 20% in 1995 to 121%. With such high debt levels, there is a risk the government may not have the financial capacity to sufficiently repair damaged infrastructure. Second, because today’s short-term interest rates in Japan are virtually zero, the Bank of Japan (BOJ) is unable to cut interest rates to stimulate economic activity as it did back in 1995, when rates were north of 3%. However, the BOJ has been able to inject money into the banking system by expanding its balance sheet (i.e., by printing money).

Even if Japan were to enter into a prolonged recession because of the earthquake, the impact on global growth would arguably be minimal. As BCA Research recently noted, Japan’s contribution to global growth has averaged just 2-3% during the past five years. BCA makes a convincing case that “this disaster will neither end the global business-cycle expansion, nor will it change the earnings outlook for the major economies. Therefore, any additional weakness in key global averages should be viewed as buying opportunities.”

Ed. note – Yesterday we covered some interesting pieces highlighting the extreme value that can be found today in Japanese small cap stocks.