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The Fear Trade
New York: March 14, 2011
By John Stephenson

Just when you thought the news couldn\\\'t possibly get worse, Japan\\\'s moribund economy was dealt a major body blow last week as a powerful one-two combination of earthquakes and a tsunami left a wave of destruction in their paths. For Japan, a country struggling to break free of two decades of economic decline, the path to recovery has been dealt a mighty blow. For investors, already rattled by a witch\\\'s brew of shifting political sands in the Middle East, rising food and fuel prices, Japan\\\'s plight could hardly have come at a worse time.

And that had investors in a selling mood for most of last week. Investors were in no mood to gamble on Europe\\\'s debt woes, China\\\'s inflation and runaway oil prices and were hitting the sell button for most of the week sending global markets lower. Earlier optimism about the global rebound was tempered by the recent reminders of multiple trouble spots that could upend the recovery from the worst downturn since the 1920s.

Japan\\\'s already dire fiscal situation just got a whole lot worse as the sheer force of the 8.9-magnitude earthquake and tsunami brought large parts of Japan\\\'s economy to a standstill. Auto makers such as Honda, Nissan and Toyota were forced to close plants and electronic firm Sony shuttered some of its operations. The damage to the country\\\'s nuclear power plants and possible core damage to several reactors has caused officials to institute rolling blackouts in an effort to conserve electrical power. The result will be sharply reduced Japanese industrial production in the weeks and months ahead.

Prior to the devastation, Japan\\\'s economy had shown signs of a recovery from two decades of decline, posting an overall growth rate of 3.9 percent in 2010. But to keep Japan\\\'s economy moving forward, the government has borrowed heavily and will undoubtedly have to borrow even greater sums to rebuild the economy after the devastation. Almost half of Japan\\\'s government spending is paid for from borrowing and Japan\\\'s debt-to-GDP currently stands at a staggering 200 percent—the highest of any industrialized nation.

Unrest in the Middle East continues unabated. While it now appears clear that Muammar Gaddaffi\\\'s regime is not going to go quietly, political commentators are speculating at the prospect of political change within oil-rich Saudi Arabia . And while Saudi Arabia\\\'s recent day of rage turned out to be a non-event, it appears all but certain that change is the order of the day for the Middle East—a fact that has sent crude oil prices soaring.

And for Japan , a country that is the world\\\'s third biggest importer of commodities behind China and the United States , the soaring price of oil is another bitter pill to swallow. Japan imports nearly all of the 4.4 million barrels of oil per day that it consumes, putting it solidly at the mercy of global oil prices.

In Europe, Moody\\\'s reminded investors that Europe\\\'s debt saga is far from over and then downgraded Spain\\\'s debt. The yield on Portugal\\\'s five-year debt climbed to a euro-era record as speculation grew that a massive bailout will be required to put Portugal\\\'s house back in order.

Further clouding the outlook for investors was recent Chinese trade data which showed that the current account dipped into negative territory as rising commodity prices took their toll. And while Chinese New Year surely had a hand in tipping the trade balance into negative territory, it was another worrisome reminder of the fragility of the global economic recovery.

The fear trade is back in vogue as China, Europe, Japan, the Middle East and the United States all grapple with a wide range of economic challenges with any single region\\\'s problems being potentially big enough to derail the global recovery. With the possibility of a slowing world economy, commodities have been for sale of late and will likely trade lower in the weeks and months ahead.

But when the dust settles and pessimism gives way to optimism over the health of the global recovery, commodities led by oil will be the best places for investors to stash their cash in the months that lie ahead. A major bout of inflation lies just around the corner as the Fed\\\'s monetary base has exploded and a bond savant such as Bill Gross of Pimco has recently made headlines by liquidating his entire holdings of U.S. treasuries. With yields on Treasuries likely to move sharply up in the months to come, Bill Gross, the world\\\'s biggest bond manager, sees an end to the bond market rally. And ultimately, a rising inflationary tide will lift the prospects for commodities and commodity producing equities, once the dust settles on Japan and the tensions in the Middle East.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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