McCall’s Call: Japan Disaster And ETFs

March 15, 2011

To sell or to buy in the wake of the worst earthquake in Japan’s history?

The worst earthquake in the history of Japan has caused seismic shocks not only to the local economy, but global financial markets as well.

Matthew D. McCallInvestors of all kinds are being affected by the disaster, which has now morphed into a potential radiological catastrophe, as damaged nuclear energy plants leak radiation into the atmosphere.

What now, many are wondering, as the world’s No. 3 economy reels in an aftermath that, given the radiation dangers, is still not yet fully clear?

It’s important to take a look at the short-term and long-term effects of the earthquake on global equity markets as well as currencies and specific ETFs. Indeed, while panic selling has already taken hold, buying opportunities for ETF investors focused on equities, currencies and even nuclear energy are taking shape.

Japanese Market

As you may imagine, Japanese stocks have so far been the hardest hit. The iShares MSCI Japan ETF (NYSEArca: EWJ) is down 17 percent in three days since the earthquake, and is now trading at its lowest level since July 2010.

The Nikkei, Japan’s broad stock market index, is on the verge of moving into bear market territory, as it flirts with a 20 percent drop from its February high. It fell 12 percent in the first two days of the week, its worst two-day drop in over 20 years.

Even though EWJ is a diverse ETF with over 300 stocks in the portfolio, when a natural disaster of such magnitude strikes, a sell-first-and-ask-questions-later dynamic takes hold. Indeed, investors are dumping anything and everything Japan-related, and EWJ has been right in the middle of it.

As cooler heads prevail, investors often bet that an affected country’s GDP will increase in the wake of any destruction, as governments and private industries pump money into the rebuilding process. This outcome is likely in Japan, but it could be months away before the spending shows up in Japanese stock prices.

In the six months following the 1995 Kobe earthquake in Japan, the Nikkei lost 25 percent before finding a bottom as the rebuilding efforts boosted the economy.

The recent earthquake and its aftermath—particularly the radiation leaks from damaged power plants—appear to be far more destructive than Kobe’s disaster, and thus could lead to bigger near-term losses for the Japanese equities market.

The Japanese Yen

Most investors assumed Japan’s currency, the yen, might fall given the broad scope of the natural disaster. But that hasn’t been the case in Japan, because as residents prepare to rebuild the country, they must first buy yen.

On Tuesday, the Rydex CurrencyShares Japanese Yen ETF (NYSEArca: FXY) rallied 1 percent to its highest level in four months and within striking distance of an all-time high. In the three months following the 1995 earthquake, the yen gained an astounding 18 percent.

I’m not expecting a rally that large in the coming months; however, the yen should hit new all-time highs and be a safe haven for investors. My firm has owned FXY for months as our safe-haven currency, and we’ll continue to hold.



Nuclear ETFs

On top of the mass casualties and destruction caused by the earthquake, the damaged nuclear power plants loom as a major concern for Japan and the world, as the radiation rescue workers have detected risks being carried on the wind to areas both in Japan and far way.

This turn of events has caused investors to run from any stocks related to nuclear power generation.

The most actively traded ETF in the sector is the Market Vectors Nuclear Energy ETF (NYSEArca: NLR), which was off 20 percent on Tuesday morning from Friday’s closing price.

The ETF is composed mainly of stocks in the uranium mining, nuclear generation, and plant infrastructure sectors. The fear is that nuclear power generation will take a major hit in the months and years ahead, slowing the demand for everything from uranium to new power plants.

An ETF that is even more concentrated than NLR is the Global X Uranium ETF (NYSEArca: URA). The Global X fund is down over 15 percent through Tuesday, from Friday’s closing price.

It’s composed of 23 stocks, mainly Canadian and Australian companies, with the mega-miner Cameco (NYSE: CCJ) making up 18 percent of the portfolio. CCJ has fallen over 20 percent so far this week to a fresh five-month low.

To Sell Or To Buy?

After a natural disaster and a subsequent market sell-off, the debate begins as to whether investors should turn into vultures and start buying depressed stocks. Or conversely, should they continue to be cautious, selling and not consider buying until all the unknowns are gone?

I tend to fall in the middle. I’m definitely not the panic-selling type of investor because, as history shows, this is typically not the best strategy. Indeed, it often results in selling at the lows.

At the same time, being a vulture is difficult, because you have to have money to lose and have the patience to let the market rally if you are too early to the party.

As far as Japan is concerned, I would hold off on buying EWJ or any Japanese-related ETFs for a couple weeks. There could be more downside before a rally occurs.

But the yen will continue to be a staple in our portfolios for a number of reasons.

Also, my sense is that nuclear-related investments constitute the one area where vultures can begin to nibble, for at least a short-term rally, off the panic selling.

And, last but not least, my heart goes out to everyone that has been affected by this horrible disaster.

Matthew D. McCall is editor of The ETF Bulletin and president of Penn Financial Group LLC, a New York-based wealth management firm specializing in investment strategies using ETFs.

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