The Japanese Disaster and the Capital Markets

Morris Segall      Capital Markets, deflation, Economic Growth, Japanese reconstruction, nuclear meltdown, reflation, stock market, stock market correction, stock market volatility

What was already a cataclysmic catastrophe in last week’s earthquake and tsunami in Japan has become a calamity of potentially worldwide proportions. On the heels of the tsunami has been a series of hazardous nuclear system failures at the nuclear power complex at Fukushima Daiichi. These failures have been caused by the destruction of water cooling systems that are essential to maintaining the safety of nuclear power plants. The loss of this water cooling apparatus has resulted in dreaded nuclear fuel overheating and potential meltdowns that would release deadly radioactive gas into the atmosphere. What appeared to be a containable situation last Friday has become a seemingly out of control nuclear nightmare, rivaling the nuclear tragedies of Chernobyl and Three Mile Island. 

This ongoing nuclear misfortune has exacerbated the Japanese disaster into one of world consequences. World capital and commodity markets have declined substantially since the proportions of the nuclear threat increased.  The declines have been severe and precipitous as concerns that the impact of the Japanese national destruction would curtail world economic growth and cause another international financial crisis. After concerning ourselves with the rising tide of inflation in our March 7th website article, the Japanese crisis threatens to unleash deflationary forces, temporarily, from diminished demand from the world’s third largest economy. In addition, the spread of nuclear radiation to Asia and the Pacific Basin would impair economic activity in the important emerging industrialized countries in that region, further reducing worldwide growth.

In the long term, the rebuilding of the Japanese economy will stimulate demand for industrial commodities, raw materials and capital goods resulting in reflationary trends and accelerated worldwide economic growth. This should be reflected in rising capital and commodity markets after the near term corrections in these markets. However, the recent severe declines in equity prices threaten to derail the stock market recoveries began last September if they continue. As we publish this post, Asian markets are stabilizing from Tuesday’s sharp declines and we expect this will spread to European and U.S. markets on Wednesday.

If equity market recoveries are to continue, the Japanese nuclear threat must be removed so reconstruction can proceed. The disposition of Japan’s nuclear problems will determine the direction of capital and commodity markets in the short term. Those problems have become unpredictable and the uncertainty of that situation is causing public and investor consternation. At this time, we are maintaining our economic and capital market outlooks and allocations (See our website article of January 6th, “Great Expectations”),  but we are watching the Japanese situation closely to see if reevaluation is necessary. The recent public market declines and volatility from adverse overseas developments fortifies our capital market strategy emphasis on private equity investment in transaction and hard asset themes and cyclical recovery emphasis on the U.S.

Morris R. Segall, CFA, CIC

Second Qtr. GDP, Ben Bernanke and Intel

Morris Segall      2009 economy, corporate earnings, deflation, Economic Growth, economic outlook, GDP

On Friday the Commerce Department released its first revision of second quarter GDP, Fed Chairman Ben Bernanke delivered the opening speech at the Fed’s annual summer retreat and Intel announced a downward revision to its third quarter earnings outlook. All of these items were important news stories and all served to cement our previous comments on our blog and website that the economic recovery in the U.S. has stalled and is in danger of aborting.

The downward revision to second quarter GDP was expected after the June trade deficit widened to almost $50 billion led by a surge in imports and a surprising decline in U.S. exports. Economist estimates dropped into the 1%-1.5% range. The actual number reported on Friday was 1.6% and the equity markets breathed a sigh of relief and rallied that the number wasn’t worse. It shouldn’t have. Details behind the headline number reveal economic growth from the last vestiges of federal stimulus that we believe will not be repeated in future quarters. So we view the revised GDP report as dangerous to the outlook for the economy going forward. Personal consumption is not improving and government and business spending in the quarter have been augmented by factors we do not believe will continue.

Ben Bernanke announced on Friday the Fed would not allow the economy to fall into a deflation cycle similar to the Japanese experience in the 1990′s. However, his speech was devoid of new details about how that would be accomplished. Nonetheless, the stock market was reassured and rallied strongly if incorrectly.

Lastly, Intel reported a downgraded outlook for revenues in the current third quarter. Of all the news on Friday we believe this was the most important because it is a warning to us of the vulnerability of the current recovery cycle in corporate earnings. A faltering in corporate earnings would remove the primary support to the stock market and a major prop to the U.S. economy.

Please see our detailed article on these items and a more thorough analysis of the economy in a new Economic Presentation we are publishing on our website, www.spgtrend.com.

Morris R. Segall, CFA, CIC