Update: Japan

by Ben Atwater and Matt Malick

Every market correction has a catalyst, which this time may be the horrific earthquake and tsunami in Japan. These unfortunate events are certainly tragic and we hope the human toll gets no worse.

For more benign reasons, beginning in April of last year, the market underwent a fairly frightening slide amidst below-consensus economic data and substantial media coverage highlighting the continuing European debt problems. During this period, the market quickly dropped 17% and stocks were once again not for the faint of heart. But, the slide ended as quickly as it began and the market produced above average returns in 2010.

When the S&P 500 hit its recent peak of 1,343.01 on February 18th, the index was trading 4% above its 50-day moving average, 8% higher than its 100-day moving average and 13% over its 200-day moving average, all signs of a frothy market.

It is not unusual to see market corrections that challenge these moving averages, so a technical correction (a 10% to 20% drop from the peak) may be underway with the S&P closing today at 1,281.87, almost 5% below the February 18th high.

The Japanese stock market has fared far worse. According to The Wall Street Journal, “the Nikkei Stock Average finished 11% lower [on Tuesday] at 8,605.15 after sliding more than 14% earlier in the day, pressured by news of explosions at Tokyo Electric Power Co.'s Fukushima Daiichi nuclear power plant's No. 2 and No. 4 reactors, on top of previous blasts at the Nos. 1 and 3 reactors. Coming on top of a 6.2% fall Monday, the performance is the Nikkei's worst since its Oct. 16, 2008, drop of 11.4%, in the aftermath of the global financial crisis.”

CNBC.com reported yesterday that “Japan’s earthquake couldn’t have come at a worse time for U.S. investors hoping for resurgence in the country’s market and economy. Last month, they poured over $1 billion into Japanese exchange-traded funds, second only to U.S. energy funds . . . according to Biriniyi Associates data.” It is always unpredictable why, how and when the contrarian case will play out, but it usually does.

Clearly, all bets are off until there is some resolution, or at least de-escalation, of the emergency at the Fukushima Daiichi plant. However, absent a more intense nuclear disaster, we believe that a correction will offer unique near-term buying opportunities among certain equities.