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How Japan's Disaster Could Impact Your Investments

Discussing the impact the Japanese earthquake could have on our 401(k)s and other investments seems terribly beside the point right now, while our hearts and prayers are riveted on the human toll that is unfolding. In the grand scheme of things, investing takes a very distant back seat.

But it is also in times of great emotional upheaval, uncertainty and yes, fear, that we can do great harm to our portfolio. The fact that the Japanese stock market fell 6.2 percent today in its first full session since the earthquake, is surely nerve-wracking, and bound to raise your investing anxiety. Add in the turmoil in the Mideast and it's absolutely understandable to feel like now's the time to do some wholesale stock selling.

Slow down. Before you make a decision to do something in light of what is happening right now, step back, and think through what the longer-term picture might look like. Here are some points to consider:

  • Natural disasters aren't permanent. From a purely financial vantage point, Japan will rebuild and recover. It will take time, but the factories and businesses that are closed today will eventually reopen; the world's third-largest economy will again produce what it has always produced, and import what it has always imported. (In fact it will likely need to import more at least in the short-term.) As Société Générale's chief economist for the Asia-Pacific region put it to the Wall Street Journal: "Natural disasters are immediately negative for growth, but tend to be positive over the medium term."
  • Japanese stocks will recover. You probably have a big piece of your portfolio riding on the Japanese stock market. More than 20 percent of the popular EAFE international index, the standard benchmark for many international index mutual funds and ETFs, is invested in Japanese companies. And as bad as the 6.2 percent plunge today was, it could in fact get even worse. After the Kobe earthquake in January 1995, for example, the Nikkei fell more than 20 percent within six months. But here's what you really want to focus on: The Japanese economy got back to work sooner than later, the index quickly snapped back, and the Nikkei had recouped its losses by January 1996. Of course, this recovery could take longer given the enormity of the devastation, but honestly, the best time to sell out of Japan was on Thursday, before the quake. Sell now and you are locking in short-term losses. Instead, try to look at this as dispassionately as some smart international money managers. Charles de Vaulx, manager of the $1.8 billion IVA International Fund, which invests in Japan, told Bloomberg Businessweek "We do not expect to make any significant changes to our portfolio as a result of this tragedy." And Oakmark's David Herro, Morningstar's 2006 International Fund Manager of the Year added:

"Our view on Japan is still the same. When you look at the valuation of Japanese companies, if you look at what's happening with Japanese managements in terms of improving operating efficiency, we're still excited about the Japanese equity market. If this causes market values to go substantially lower, we'll use this as an opportunity to buy quality at lower price.... Very little of this will ultimately impact the long-term price of the companies we own."

  • U.S. Treasury bonds could face even more pressure. Japan's current $882 billion investment in Treasuries makes the country the second largest foreign owner of our federal debt, behind only China. One potential result of the earthquake is that Japanese businesses and the government would cash in their Treasuries to bring money back to Japan to pay for the damages and reconstruction. It isn't clear if this "repatriation" will in fact occur -- and it may be offset by other global investors flocking to the safe harbor of the U.S. market in the wake of the Mideast turmoil. But Loomis-Sayles' Dan Fuss, one of the best bond managers for decades, points out that even if the Japanese don't end up selling their Treasuries, their need to plow money into their own economy means they will have less cash available to park in our bonds. "A big buyer of bonds is taken out of the market...Japan will be less able to add to their reserves and less able to buy Treasuries," Fuss told Yahoo.

The reality, though, is that the potential negative impact of the Japanese earthquake is just the latest reason to be wary of Treasuries. Any fallout would just be the latest prick to the much discussed bond bubble. In fact, last week, right before the disaster, Pimco's Bill Gross announced that his firm is hightailing it out of Treasuries in advance of the coming end of the Federal Reserve's Quantitative Easing II program (QE2). The Fed's program has kept bond yields lower than they might normally be; Gross and others anticipate that once the Fed stops being the buyer of first resort in the coming months, the bond market will insist on higher yields (and thus lower prices) before it is enticed to buy.

  • Doing nothing could well be the right thing to do. While it is rational to be anxious about how this will all play out in your portfolio, acting on that anxiety may not be as rational. As MoneyWatch blogger Larry Swedroe, who is director of research at Buckingham Asset Management, noted in a recent post, there will always be shocks and surprises, whether natural disasters, geopolitical upendings, or straight-on financial crises. Stuff happens. Really bad, scary stuff. But the markets endure. Recoveries materialize. It can take months, or years. And there are of course no guarantees. But if you were already investing -- and investing for long-term goals -- sticking to a well-thought out, diversified investment strategy is likely the best non-move you can make right now. And the singular best money move for right now? Consider a donation to any of the many organizations providing emergency aid to the victims of the Japanese earthquake.

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