Yesterday’s Financial Times featured an analysis by Lindsay Whipp titled “A gloomy anniversary for the Nikkei.” Most investors already know the punchline: The Nikkei, Japan’s primary stock market index, reached a peak of 39,000 twenty years ago. Today, the index hovers in the mid-10,000s, almost three quarters below its peak. Given the United States’ similar issues with high levels of debt, stock market (over) valuation, as well as similar monetary and fiscal responses to “fix” the initial credit crisis, investors in US equities should ask the question, is Japan the correct analogy?
Unfortunately, in many ways Japan does appear to be a reasonable corollary. Post World War II, from 1950-1970, Japan's GDP grew at a real rate of 8.4% annually on a per-capita basis. It slowed to a still stellar 4.1% rate from 1970-1990. Then, the bubble burst and from 1990-2004 Japan's economy grew at an average rate of 1%. The Japanese market’s slow bleed has led to a -6.4% annualized return over this period.
What happened? Similar to what we just experienced in the US, the late 1980s in Japan saw monetary inflation that led to tremendous asset price inflation in both residential real estate and equity markets. The government reaction after the bubble burst was very similar to the US government's reaction to date. The Japanese government propped up insolvent banks and built bridges to nowhere. It redistributed existing wealth rather than allowing creative destruction to work its magic by purging excess and encouraging new development. While Japan did use monetary policy to combat deflation, it was far less aggressive than the US has been to date and a period of mild price deflation has persisted.
The economic ramification of the analogy are clearly quite negative, but there are several additional insights investors might find useful:
In conclusion, we think that while not a perfect analogy (owing to distinct demographic, immigration, and consumer behaviors to name just a few differences), the last twenty years in Japan provide a very useful template to inform current investment decisions in US markets. We believe a process that is oriented toward value investing, displays the patience to wait for the market to present opportunities, and is mindful of the damaging impact of an unstable currency has the potential to offer both positive absolute and relative returns in even these very challenging conditions.
Categories Behavioral Finance Diversification Economics Efficent-Market Hypothesis Inflation/Deflation Investment Process Portfolio Management Valuation Pages About Archives December 2009 (1) November 2009 (1) October 2009 (1) September 2009 (1) August 2009 (2) Latest Articles Is Japan the Correct Analogy? The Deeper the Slump, the Stronger the Recovery? Greenlight’s Einhorn Allows Us to Learn from His Mistakes Financial Advisers Exhibit Harmful Bias Too Not All Diversification is Created Equal The Concept of Duration is not Just for Bonds© 2009 Grey Owl Capital Management, LLC. All Rights Reserved.
Consumer Disclosure Privacy Policy© 2009 Grey Owl Capital Management, LLC. All Rights Reserved.
Read Full Article »