the Lost Decades
Today, I’m going to expand on yesterday’s post by writing about features of the “Lost Decades” in Japan that I think might be repeated in similar circumstances elsewhere.
Before I start, however, I want to make two points:
–I don’t think the US is the new “Japan”; the EU would be a better candidate, in my opinion, based on its behavior toward its banks, its money policy regime and the way many countries intrude into the workings of their equity markets. But I don’t think it’s anywhere close to being another Japan, either.
Instead, I’m reading the current downdraft in world markets as an adjustment to two realizations:
that economic growth in the US and EU will potentially be much slower in the next two or three years than in 2009-10, and
that no more government support for markets is forthcoming.
The removal of the implicit safety net is the bigger deal, to my mind. I’ve been thinking–and writing–for a long time that the slow growth/high unemployment problem is a social and political one that won’t affect corporate profits much. I still think so.
–To (my) Western eyes, the Tokyo stock market was a very peculiar place twenty-odd years ago. Back then, the government was actively involved in controlling the stock market, in much the same way that governments typically control their bond markets.
at times, Japanese brokers were not permitted to accept sell orders for domestic commercial banks–at least from foreigners.
Large amounts of trading were done in specially segregated trusts, to make it clear that the parties were not disrespecting one another by liquidating stockholdings established to cement business relationships. These tokkin “portfolio managers” typically worked in large smoke-filled rooms that housed scores of them, all trading off price movements posted on large electronic “scoreboards” erected along one wall. No research, no portfolio planning–just trading on hunches or “hot” tips.
Women were legally barred from purchasing warrants (don’t ask me why).
If you want to see something really weird, read my post on tobashi.
Despite these unique quirks, I think there are aspects to the Japanese experience that I think would apply elsewhere. And, of course, it’s always good to think out alternate scenarios, just in case they become more probable, or because you find your initial assessment was wrong.
Three factors stand out to me:
1. It took years for valuation differences to matter much.
At the top of the Japanese market in 1989, there were very substantial valuation differences between domestic-oriented stocks, especially property companies, and export-oriented manufacturers. By then, domestic names had reached price earnings multiples of many hundreds of times; even cement firms, which typically sport single-digit multiples all around the world, were trading at 100+ times eps. Export-oriented manufacturers, on the other hand, were at multiples of perhaps 20.
In addition, the first decision any Japanese portfolio manager makes is whether economic growth would be better inside Japan or outside. That would determine whether the portfolio would have a domestic or export orientation. So both valuation and concept pointed strongly toward favoring export over domestic. But in the first part of the 1990s this distinction made very little difference. Everything fell–a lot.
As a result, valuation discrepancies between sectors remained for years. In this regard, the Tokyo market resembled the US market during the 1973-74 period rather than the post-Internet bubble years of 2000-2002.
2. Dividend yields gave no protection, either.
The combination of low interest rates and sharp stock price declines eventually created a situation where the dividend yield on the Topix index exceeded the coupon on the ten-year government bond. Nevertheless, higher income did not serve to attract investors. The operative logic seemed to be that, yes, I might get a 1% pickup in yield over a government bond, but I’ll lose that if the stock declines by even 1%–something that could happen in a heartbeat.
3. Individual investors deserted the market–and didn’t return.
Domestic individual investors in the Japanese stock market tended to be of two types:
–ordinary individuals, who leaned toward very mature, traditional companies which traded at low absolute per share prices. These were, generally speaking, poorly run. But they were the subject of intense speculative activity because of their “hidden asset” property holdings. So they were good performers in the 1980s. In the 90s, however, owners were pretty much wiped out.
–semi-professional investors, typically CEOs of small companies who invested the company treasury in stocks. They, along with foreign investors, tended to focus on smaller, fast-growing firms–which tend to trade at high absolute prices. These investors were hurt both by the withdrawal of foreigners from the market and by the deterioration of their businesses in the poor economic environment.
Both types left the market for many years.