As Japan Teeters, Investors Place Their Bets
Will the earthquakes, tsunami and nuclear crisis in Japan shake investors’ resolve and derail the market’s bull run? That’s a question many market watchers are asking as stocks have tumbled around the globe.
As the world watches and waits for more clarity on the human and economic toll from the disaster, strategists, stockholders and traders who have bullishly backed stocks are reassessing the next move for equities.
“This catastrophe has dramatically changed the landscape and economic models will have to be redrawn to take all of this into account,” says Kenneth Polcari, managing director at interdealer broker ICAP.
The US stock market has shown tremendous resiliency during a two-year rise that saw the S&P 500 double from the depths of the financial crisis in March 2009 to its recent peak February 18. All the while investors have weighed ongoing political upheaval in Northern Africa, the subsequent spike in energy prices, and more European sovereign debt downgrades in that ongoing crisis.
Of course, there are continued concerns over sluggish job growth, inflation and a budget crisis right here at home. And there are serious questions about China’s growth and the outlook for continued expansion in emerging markets.
“I think market behavior over the past month has been surprising -- surprisingly resilient, not weak, given all the recent news,” says Gerard Minack, Global Developed Market Strategist for Morgan Stanley. “Almost any of these (events) in isolation could have been a catalyst for a correction to markets that, by February, appeared tactically stretched. That in combination they have set back developed market equities by less than 10% is impressive.”
This week’s selloff coupled with a break of the market’s six-month long uptrend is creating opportunities, both long and short.
“A dip to buy, not sell”. That’s the title and thesis of David Bianco’s report this week. Bianco, the head of U.S. equity strategy at BofA Merrill Lynch, argues stocks in the S&P 500 are still undervalued compared with their expected earnings and relative to their historical valuation.Bianco also notes the risks of exiting the market after a sell-off and then trying to buy back in after the risks have subsided. He says this strategy “usually significantly underperforms a simpler strategy of just staying invested…because it also misses the best days, which tend to closely follow the worst days.”
Professional trader Fari Hamzei takes the other side of that trade. Hamzei, currently the top-ranked market timer by Timer Digest, turned bearish two weeks ago and he’s sticking with that call. The founder of Hamzei Analytics has been betting on a decline since then.
“With the news cycle right now, if I get caught (on the wrong side of a trade) I can’t even get out,” Hamzei explains. “I don’t want to buy some dips and not be able to get out because of panic.
Hamzei and his colleagues are looking at the market’s performance this week and comparing it with the Chernobyl nuclear meltdown a quarter century ago.
The S&P 500 rose the first trading day after that disaster, as it did last Friday after the Japan quake, before sliding for several days. A month later, the S&P 500 had recovered all of its losses.
In a similar strategy, Birinyi Associates notes it took 14 trading days for the S&P 500 to hit its lowest point, a 4.25% decline, after the Chernobyl incident. Six short days later it had fully recovered. “We expect this decline to be short-lived. Chernobyl was only 20 trading days. There are about 250 trading days in a year; it’s a drop in a bucket. According to what we’ve seen, it’s right in line with US and Soviet crises.”
Birinyi also looked at market reactions to nuclear plant incidents at Michigan’s Fermi 1 reactor in 1966 and Pennsylvania’s Three Mile Island in 1979. Each of those episodes was followed by shorter and shallower declines for the S&P 500, which fully bounced back both times in just six days.
Rob Leiphart, an analyst at Birinyi Associates, attributes the shorter selloffs to greater transparency by the U.S. government versus the shroud of secrecy by the Soviets, who initially denied a major problem at Chernobyl.
”I think the cloud and question marks over Chernobyl were what perpetuated a longer instance of the decline. I think in order to figure out whether this is Chernobyl or Fermi/Three Mile Island, we need for some questions to be answered first.”
While they wait, Leiphart and his colleagues are looking for what he calls U.S.-based, industry leaders. “We’re still bullish and if anything, this provides a buying opportunity,” the Birinyi Associates analyst says. “We’re picking stocks and looking for opportunity, and an event like this provides us with that opportunity.”
The firm has notably been buying stocks since becoming one of the first on Wall Street to publicly turn bullish just before the bear market trough two years ago.
While Birinyi Associates sees the uptrend continuing, another strategist who correctly called the ’09 market turn (among others) says it’s time to “hit the bid” by selling while there are still willing buyers.
“It’s a major change for me,” explains the previously bullish Michael Belkin. Last week he advised subscribers to his Belkin Report to sell tech, industrials, and materials. In the March 7th Report entitled “Risk Off”, Belkin basically told his professional money manager clients to cash in the very winners he had advocated buying since September. He wrote, “We recommend harvesting the gains of the six-month rally and getting defensive.”
That note ominously told of a “threatening” three-month forecast for Japan, a stock market he had been recommending. That threat arrived sooner than expected and in a form Belkin says he “could never have imagined.”
Belkin’s proprietary model helped him make prescient market calls in the dot-com bubble era, flashed a sell signal well before the market’s collapse in 2008, and alerted investors to get bullish early in 2009.
Now the strategist warns his money manager readers to “don your helmets” as he sees big price swings amid renewed volatility ahead.
The theme in this week’s letter: closing long equity positions, shorting stock indexes around the world, and buying US Treasuries.
Belkin says the confluence of geopolitical and geological events may mark the end of the bull market: “This could turn out to be a major top, rather than just a brief correction.”
Morgan Stanley’s Minack is not quite that bearish. Although he has been cautioning the run up for developed stock markets was almost over, the Sydney-based Minack still sees elevated levels near-term. “I still think markets can regain their poise and make a new high this half. Then a tougher second half.”
Some investors are prepared to embrace the renewed market volatility and even buy Japanese equities. Larry Jeddeloh, chief investment officer for TIS Group in Minneapolis, remains bullish on that nation even after the disaster. “I am waiting for the worst of Japan’s news to hit,” he writes.“Then I think we will add exposure to Japanese equities, perhaps significantly.”
Jeddeloh does offer a caveat that many anxious investors can relate to at this inflection point: “Much depends on what happens during the next week or so.”