Jason Stipp: I'm Jason Stipp for Morningstar. With the Japanese markets booking a second day of steep losses and U.S. markets also dipping in response to that, I'm checking in with Morningstar markets editor Jeremy Glaser and Christine Benz, director of personal finance, to put some context around these global events and what it means for investors.
Thanks for joining me.
Christine Benz: Jason, great to be here.
Jeremy Glaser: You're welcome, Jason.
Stipp: So, Jeremy, I'd like to start with you. You used to be a stock analyst, so I wanted to get some insights about valuations, because certain factors will move the needle on a company's fundamental value and cause it to be worth less, but then there is also a factor of fear that's out there that's also moving the valuations around. So, as a stock analyst, if you were looking at some of these holdings, how would you start to get a handle on whether they are oversold or whether they are moving commensurate it with what the risk is out there?
Glaser: As is often the case, Warren Buffett has a great quote for the situation: That in the short term, the market is really a voting booth, while in the long term, it's a weighing machine. Short-term price volatilities are always going to be there. If people get afraid that there is going to be really much slower growth in the future because of this event, and that's going to really impact a company's earnings, you're going to see the stock sell off, just really out of fear that people just want to get out of the market.
But we hope over the long term that the market will really assess the true value of a company's earnings, the true value of their earnings potential, and that you'll get that fair value for it, you'll get that intrinsic value for the stock.
I think that investors, when they're looking at their holdings, need to think carefully about if the earnings potential for this company has been permanently impaired or even temporarily impaired. So, how does a particular company make money, where are their operations located, are they reliant on a lot of suppliers that might have been impacted by the events in Japan? And then think carefully about what the future demand for their products is going to look like.
So, for some companies, this event is going to very much impact their future demand curve. So, if I was someone like Shaw Group, who provides a lot of different types of materials and different types of engineering and construction help for the nuclear power industry, you're probably going to see a pretty different growth trajectory going forward, but if it's someone like Coca-Cola or even Toyota Motors, you're probably not going to see a really large change over time. So, certainly Toyota has a lot of operations in Japan--they are a Japanese company--but they also have cars around the world, and I don't think that the global demand for cars is going to fall precipitously because of this event.
So, thinking carefully about long-term earnings power, and not short-term noise, should help you get a better sense if the move is really just fear and market related, or if it's a true problem with the company's business.
Stipp: A quick follow-up for you. Certainly, we've seen a lot of volatility, and there is still a lot of uncertainty out there. So, when you're looking at the value of the Japanese market, for example, that value today isn't necessarily what that value will be after some of this uncertainty is cleared up. So, I think people tend to look at the stock price and say, that's what the stock is worth right now. But really that's kind of discounting a few different scenarios, right?
Glaser: Exactly. That might be what we can sell it for right now, but when you're thinking about what the stock is selling for, even what you think the company is worth, you have to think about a bunch of different scenarios. Really you come up with one point estimate, but it could be worth a lot of different things.
So, in the worst-case scenario, it might be worth much, much less if there is a situation where the nuclear power plants in Japan, if that situation becomes much worse much more rapidly, and people really have some very serious problems there. You could really see demand fall off precipitously. This is a real problem. We're trying to in any way minimize the potential impact on the world's economy this event could have.
But in the best case scenario, and things get contained relatively rapidly, and things move back to their normal pace rapidly, a stock could be worth much, much, much more. And you have to come up with some kind of weighting to say, how likely is that best-case scenario versus that worst-case scenario? Of course, there are a lot of things between to come up with what the stock price is today or to come up with your own fair value estimate.
So I wouldn't anchor too much on where prices are right now. I'd anchor more on your probability and how you really think that things are going to play out in the future. If you think that Japanese stocks haven't been impaired by 20%, which is why they're down since Friday, then you might think that things are undervalued right now. If you think that the worst-case scenario is more likely, than perhaps there could be more sell-off to come.
Stipp: Christine, I think this is happening at an interesting time that we're seeing this disruption in the market, because we're about the two-year anniversary of the low of the last big crisis, the credit crisis, and we actually had written on Morningstar.com a little bit about some of the lessons from that low. Can we apply any of those? Obviously, the situation is very different in any number of ways today than it was two years ago, and what's causing the disruption. Could we apply any of those lessons, though, that we learned during that major market disruption we had a couple of years ago?
Benz: I think you can, Jason, and obviously, the magnitude of this [market] event is much less than that giant financial crisis we saw play out over several years, but I think one of the key takeaways is the pitfalls of doing some of that panic-selling that a lot of investors were inclined to do at the market bottom. Our colleague Dan Culloton did some interesting research looking at what investors were selling during that last market low in early March 2009.
It was some of the large-cap fund categories, world stock, and he found that, lo and behold, those categories went on to deliver something like 40% annualized returns over the next couple of years. So the very things that people were selling went on to perform really well, and some of the categories that they were buying instead, so some of the short-term bond categories, intermediate-term bond, they delivered positive returns, but certainly nothing like the stuff that they were selling.
So panic-selling is rarely a good idea. I think it comes back to having an asset allocation framework that make sense for you--letting that drive your positioning rather than responding to some of these stimuli that can be very dramatic, can be very upsetting, but typically they shouldn't be an impetus to buy or sell.
Stipp: So, Jeremy, obviously very important to focus on your plan, focus on the fundamentals. On the second point, we have a group of stock analysts, and you checked in with a few of them today. What's their thinking about the fundamental shifts that might be occurring because of what we're seeing in Japan?
Are they planning to change fair value estimates in any certain industries, or are they looking to potentially say that they would recommend certain industries as being oversold. What's your general sense right now?
Glaser: There is certainly no expectation for wholesale changes to fair value estimates across many sectors, like we saw during the financial crisis where the lack of funding certainly made it difficult for almost any industry to function.
I think areas where there may be some targeted changes, or areas that I think will be under very careful review, will be mostly in the energy sector. I think that's where a lot of the first-order type of difficulties and the first-order changes from this event are going to be felt the most.
Obviously, there was some talk of a nuclear renaissance coming, that there will be a lot of new reactors built in Asia and even here in North America and throughout Europe as well, and that seems like that's unlikely to happen in the near future. Germany is taking some of their reactors offline. I think there's not going to be a lot of appetite in the United States for those kind of advancements, either, and certainly in Asia, there could be some slowdown. So I think companies that deal directly with that, and people who are very highly levered to that sector could see some fair value estimate changes just due to the fact that their true demand, their fundamental earnings powers are really changing.
On the other side, there are some industries such as coal and maybe some of the oil and gas and LNG (liquid natural gas) players that may see demand for their products pick up as they have to replace those energy sources that might come offline in other places across the world.
So, I think it's still a little bit too early to tell exactly what all the long-term changes will be. I think the energy sector is one area that could see some, but there is not going to be enormous changes in valuation levels across different sectors, including energy.
And then in terms of areas that look attractively priced, I think it's about the same as we had before. One of the things is that the market is pretty fairly valued right now. There aren't huge pockets of opportunity, and the ones that were there continue to be there, and we haven't seen such huge selloffs, at least in the U.S. market, that we're seeing great new opportunities for investors that weren't there before the crisis.
Stipp: Christine, looking at the portfolio more holistically, assuming that we are able, hopefully, to have some stability in the market, how can investors make sure that they have their portfolio set up in a way where they can ride through some of these rough patches? So, we hope this one is a short rough patch. We still really don't know how much volatility we'll see. How can I get ready, though, for this continuing on or for another event that might happen?
Benz: I think that's realistic Jason, because, you know, you sort of think back on the past two years, they've actually been pretty placid as Jeremy and I were discussing, given all we've seen in Europe, in the Middle East over this time frame. So, given that the market in aggregate is pretty fairly valued looking right now, investors have to brace themselves for more shocks inevitably due to whatever.
So, I think the best way to combat that is diversification and asset allocation, of course, boring messages, but really quite tried and true.
So, for retirees who are pulling from their portfolios to fund their living expenses, two to five years worth of living expenses held in cash or maybe short-term bonds, some combination, makes a lot of sense and can really help them ride out periods of market turbulence, because they do need stocks in their portfolio for that long-term growth piece, but for the near term, they need things to be pretty stable if they are pulling money out.
So, making sure you have those assets earmarked in cash, and even if you are not retired, making sure that you have that emergency fund carved out, or if you have any near-term expenses coming up, whether it's your property taxes or your college tuition bills, making sure that that is sitting in cash or maybe some very safe short-term bond or bond fund, is the way to go and really the way to make sense of times of market turbulence like this one.
Stipp: So, it's not that retiree shouldn't be in stocks; it's that they shouldn't only be in stocks at a time like this?
Stipp: Jeremy, she mentioned that we had been through a period where it's relatively placid in the markets. We did have some disruption with the European crisis last summer, but that seemed to get resolved at least in the short term where the markets calmed down a little bit. What's your sense on the triggers for volatility that we might see even beyond the current crisis in Japan?
Glaser: To echo what Christine said, it's kind of amazing that we've had kind of the placid markets that we have considering what's been going on in the world. This week alone, we saw the government of Bahrain inviting Saudi troops to come over the border to help quell some of the violence that's been there, some of the uprising against the ruling class in that country.
Libya continues to be embroiled in what looks like it could be a protracted civil war. We are still not sure exactly what the outcome in Egypt and Tunisia will be, or throughout the rest of North Africa and the Middle East. Those are big global events that are certainly making headlines and will continue to make headlines and could have an impact on the global economy.
But even closer to home in the United States, we're gearing up for the 2012 presidential election. We are going to hearing more and more about different candidates, the potential that they could have for our fiscal policy, for how they are going to tackle the budget deficit. We see in Wisconsin and the state capitals across the country that there is a lot of discussion about state spending and getting state budgets in line, and the impacts that could have on growth and impacts that could have the amount of money that people are taking home through tax increases or tax decreases in some cases. Certainly, that's going to have a big impact.
Even closer, there could be a government shutdown over the budget, really, in just a couple of weeks. We keep putting it off and keep coming up with continuing resolutions, but there is a chance that those negotiations will break down. I think government shutdown could have a lot of serious impacts on economic growth in the United States.
The European debt crisis is still not over. We don't talk about it as much, but European Unions, especially of the Euro zone, continue to get together and continue to fail to really come up with a credible plan to completely get rid of some of these issues instead of just putting stopgap measures in place. Greece and Ireland are still in trouble; Spain and Portugal could get into even deeper trouble. That's another potential catalyst.
So, even just in those few areas, you can see that there is a lot of potential hotspots, and not to be too doom-and-gloom about it, I think that these are serious issues, and I think that for a while after the financial crisis, we were just so relieved to be past the crisis that things that may have been major 10 years ago, we were able to kind of take in stride because it just wasn't as terrible as the whole system seizing up. But I think as that fades further into the memory, a lot of these issues that crop up could really jolt investors.
Stipp: So, Jeremy, that's a long list of concerns that should be on investors' radars, but I would like to end just talking a little bit about Japan specifically. Now assuming that they can get past this real crisis period where there are lots of concerns about the nuclear situation. If they can get past this, what might a road to recovery for that economy after this crisis look like for them?
Glaser: Certainly, nobody has an answer to that question, but I think it's clear that growth will be certainly hurt in the short term, possibly quite substantially, and then during the rebuilding phase, we'd expect for growth to pick up pretty substantially as well, as a lot of money in a lot of projects will need to be spent to rebuild the infrastructure in Japan.
We're already seeing a lot of yen being repatriating into the country. Famously, Japanese housewives trade currency during the day, a lot of the reason is that, the almost 0% interest rate you'll be able to get on yen denominated holdings for so many years drove people to hold money in other currencies. Those household savings are coming back. That could be a potential boost to the Japanese economy.
I think one of the broader questions is how the political economy and the political system of Japan reacts to this crisis. Mohamed El-Erian had a piece earlier where he described the fact that the Japanese government may really be able to use this as a catalyst to make a lot of changes that have needed to be made throughout the economy for a long time. This might give them the political will to do that.
Japan's had a moribund political system for so long--it seems like there is a new prime minister every six months or every year--a lot of changes at the top, and they haven't been able to make some of those significant structural reforms to the banking sector, amongst other things, to really get back onto a ground for solid growth. So, I think certainly there is somewhat of a more best-case scenario in which they are able to get past the short-term pain quickly, are able to heal those personal wounds, and then rebuild, get their growth back, reform the political system, and be back on a strong trajectory.
It's still, I think, again, too early to really make a prediction if that's what will happen, but I think certainly it's a possibility that Japan will be able to emerge from this crisis as a strong global player. They are a rich country. They are one that is going to spend the resources to really, I think, really bring back their infrastructure, and I think it's an area that investors are going to be looking at for a long time.
Stipp: Jeremy and Christine, some great context on the situation going on right now in Japan, and for the portfolio as well. Thanks for your insights today.
Benz: Thanks, Jason.
Glaser: You're welcome, Jason.
Stipp: From Morningstar, I am Jason Stipp. Thanks for watching.