Rebuffing Warren Buffett: Japan Is Not a 'Buying Opportunity'

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It's pretty daunting to take on the Oracle of Omaha. Warren Buffett, the billionaire investor and chairman of Berkshire Hathaway (BRK.A), recently stated that the extraordinary events in Japan offer a "buying opportunity." Buffett believes the massive earthquake could prompt a new bout of stock buying.

Is he right? Should you overweight your portfolio with Japanese stocks and take advantage of this "opportunity." I don't think so.

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A real "buying opportunity" exists when stocks are mispriced. Six billion investors are looking at the price of Japanese stocks. They know every public fact about these stocks. They are well aware of the devastation and uncertainty caused by the earthquake and the instability of the nuclear reactors in Japan. They also understand the rebuilding and government stimulus that is likely to follow in the ensuing months and years. The collective wisdom of these traders has determined that the current price of Japanese stocks is a fair price, taking into consideration all of this news.

In his excellent book, The Wisdom of Crowds, James Surowiecki demonstrated that diverse crowds looking at the same data typically make an accurate assessment. That's precisely what is happening with the determination of the price of Japanese (and all other) stocks and bonds.

There is no "buying opportunity" if Japanese stocks are fairly priced. Investors will not earn above-average returns by investing in these stocks without taking above-average risks. It is the amount of risk undertaken by investors that determines the amount of return.

The Nikkei 225, a stock market index that consists of 225 of the largest publicly traded companies in Japan, increased from 10,000 in 1985 to over 38,000 in December 1989. Investors in Japanese stocks made a bundle if they bought the index early in that decade. Since then, it has been quite a different story. The Nikkei 225 closed at 9,206 on March 18, 2011. The past twenty years has hardly been a "buying opportunity" for investors in Japan.

Prepare to Wait

The current level of uncertainty in the Japanese economy has caused the prices of Japanese stocks to fall. Buyers of those stocks should understand they are taking on the risk of that uncertainty. Over the long term, investors are likely to earn a return that will reward them for stepping in at a time where others were fearful. This reward is unrelated to speculation about the price of Japanese stocks. It is directly related to the current risk of those stocks.

If you decide to take the plunge and buy Japanese stocks, the high risk of those stocks means you should be prepared to wait a long time to reap those expected returns. If you are investing for a short-term killing, you are likely to be disappointed.

The markets are unforgiving. They extract a price for the possibility of high returns. That price is "risk." "Risk" is a two-way street. High risk can mean high returns, but it can also mean significant losses. Just ask anyone who bought the Nikkei 225 since December of 1989.

If you are considering the purchase of Japanese stocks, remember this: Someone will be on the other side of that trade. Don't assume you know something they don't.

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