One of the facts of life about being in the investment business is that every day is different. Pretty much anything and everything that happens in the world has an impact on the financial markets, and of course, one never knows what will happen next. The terrible events in Japan are a case in point.
The tremendous loss of life, the destruction of thousands of homes and the displacement of millions is a catastrophe on a huge scale. The lives of everyone involved have been irrevocably changed, and it will be years before a semblance of normality returns to a huge area, home to millions of people. It would take a heart much harder than mine to look past the human suffering in order to measure the economic impact of this disaster, but markets are not human, and they have no hearts. The Japanese stock market opened as normal on Monday morning, followed by Europe and North America. Like it or not, investors were affected by the Japanese earthquake and tsunami, and the impact will be widespread and long lasting.
At 9:30 on Monday morning, the shares of Cameco, the giant uranium miner, opened down 23%. Investors worried that the problems with Japanese nuclear power stations would reduce the world wide demand for nuclear energy, and thus for uranium. If this turns out to be true, workers in rural Saskatchewan could see their jobs washed away by a tsunami on the other side of the world. Conversely, companies involved in solar power saw their shares take off, as investors looked for a plausible alternative to atomic energy.
From insurance companies which will suffer huge losses to construction companies which can look forward to years of work, the market quickly sorted out the likely winners and losers.
Stockowners everywhere saw their careful calculations made obsolete in an instant by unexpected events in a far off land.
So what is the average investor to do? Here are three ways to reduce the impact of the unexpected.
First and most important, diversify. It is one thing to see 3% of your portfolio sink due to an act of God; quite another to have 20 or 30% of your holdings savaged by the same event. Diversify by geography, by industry and by size of company. A good rule of thumb for most investors is to avoid having more than 10% of a portfolio in any one company, or 20% in any one industry.
Second, recognize that some sectors are inherently more risky than others. MacDonald’s may sell fewer hamburgers tomorrow than they did today, and Tim Hortons may sell more donuts next week than they did this week, but in neither case will we see those stocks go up or down 20% in a day. Make sure your portfolio has some safe, boring stocks if you have also bought some volatile ones.
Finally, remember that investing is a marathon, not a sprint. Economic impacts can appear devastating in the short run, but over time, may prove to be much less damaging than originally thought. My own belief is that most of the nuclear power stations currently being designed will still be built, but maybe a little later than planned and with more safety features.
As a professional investor I accept that things will happen that cannot be predicted. My job is to take steps to reduce the impact of whatever might happen in the future. You should do the same.
The author and clients of Baskin Financial own shares in Cameco and Tim Hortons