It’s been an odd, disturbing month, to date:

–three prominent failed IPOs–ARM, Instacart and Birkenstock

–no clear sign yet that interest rates have peaked

–no Speaker of the House, with, absent legislative action, potential default on Treasury securities weeks away

–Trump is apparently arguing in court that he should remain on the ballot for the 2024 election despite his attempt to overthrow the government after his loss in 2020, because he had no duty as the sitting president to support the Constitution

–retailers like Target, Walmart and Dollar General continue to complain of unusually high levels of theft in their stores. I found the shaving cream in my local Target all locked up this morning

–the Chinese, UK and German economies are on the ropes

–the horrific attack by Hamas on Israel seems to suggest, at the very least, renewed instability in the Middle East

In sum, lots of storm clouds and few rays of sunshine.

Look at the stock market, though. Month to date, through 10/11, returns are as follows:

Communication services +5.4%

IT +4.6%

NASDAQ +3.0%

S&P 500 Growth +2.8%

Industrials +2.2%

S&P 500 +2.1%

Real estate +2.1%

Consumer discretionary +1.5%

Healthcare +1.4%

S&P 500 Value +1.2%

Utilities +1.0%

Materials +0.7%

Financials +0.4%

Russell 2000 -2.1%

Staples -2.7%

Energy -3.4%

The returns, ex the Russell 2000, which represents mid-sized, US-focused firms, are generally positive. Energy, which follows its own drummer most of the time, is down despite trouble in the Middle East and the onset of winter heating season in the northern hemisphere. Staples, a defensive group with lots of exposure to Europe, is the only other sector in the minus column. Growth is outperforming Value, meaning offensive stocks doing better than defensive.

Yes, we’re only talking about a small number of trading days. But we’re arguably still in a seasonally weak part of the year. My point, though, is that if we look only at how the overall US stock market is performing, you’d think we don’t have a care in the world–except for maybe smaller firms focused on mostly domestic customers.

I don’t mean to suggest I think the market is going to run away to the upside. What the numbers say to me is that we’re in a market of individual stock stories, where macro factors won’t count for a lot (unless you’re pondering buying Chinese property stocks), but where a low-ish PE multiple and accelerating earnings growth will be rewarded.

…post-1989 Japan.

There are very clear cultural similarities between today’s US and Japan back then, and now, for that matter–deep nostalgia among older conservatives for a lost 19th-century past, belief in the “sacred” nature of the homeland, widely held anti-woman, anti-immigrant and anti-minority group stances. History shows us what all this has brought Japan–a third of a century (and counting) of economic stagnation and a loss of relevance on the world stage.

But these similarities are not what I mean.

In 1985, Japan’s international trading partners forced a doubling of the exchange value of the yen vs the dollar from 250/1 to 125/1, ushering in the short-lived endaka (high yen) era. This triggered a collapse in the profits of the export-oriented industries that had been Japan’s growth engine–which, of course, was the whole point of the revaluation. The Japanese central bank lowered interest rates to near-zero to try to compensate. In addition to this stimulus, the revaluation caused the worth, measured in foreign currency, of domestic assets–bonds, cash, property, streams of yen income–to skyrocket. And the ultra-low rates caused PE multiples for everyone not an export-oriented manufacturing stalwart to explode.

The Topix index tripled between 1985 and the end of 1989, with the currency gain lifting the US$-denominated result to 6x.

As time passed and all the reasonable stocks had gone up a lot in price, and encouraged by ultra-low rates, the Tokyo market took on a more and more speculative tone. Toward the end, “story” stocks, increasingly more preposterous, began to dominate trading. Corporations began to issue large amounts of bonds to get money they turned over to brokerage house asset managers–by no means the best/brightest–to invest in Japanese stocks, and who basically lost everything in loony speculation.

And then the head of the central bank popped the bubble by starting to raise interest rates in 1989. The market fell by over 30% in the ensuing 12 months.

finally, my point

Faced with staggering losses, corporate Japan decided to cover them up rather than disclose the damage managements had done to themselves and their shareholders.

My worry is that the same thing could easily happen here. We’ve already seen this with Lehman during the 2007-08 housing crisis, with the then infamous “Repo 105,” similar to the Japanese “tobashi.”

I don’t expect the extremes, or the oddities, we saw in Japan in the 1990s:

–a major commercial bank in Tokyo, for example, manufactured fake financials to show to government regulators and hid the real, loss-ridden ones in a nearby women’s bathroom–on the idea that the regulators would never allow a woman to become a member of an important audit team. That belief turned out to be incorrect. or,

–Olympus hired a foreigner as CEO to modernize operations. While investigating a set of mysterious billion-dollar-plus balance sheet entries, apparently involving a bogus, yakuza-linked acquisition made to cover losses elsewhere, he was summarily fired. He immediately fled the country for the UK, where he reportedly asked for police protection because of death threats he had received.

I also think any big problems will be centered in private equity or hedge funds, rather than in publicly traded equities. I worry a bit that large retailers may still be stuck with excess inventories that have been treated in an over-generous way on the balance sheet. But such issues should be gradually fading away. And almost anyone may now regret over-aggressive expansion carried out during the pandemic.

All in all, I think it’s a time for simple ideas and low valuations, rather than swinging for the fences with exotic new things.

A friend sent me a note a while ago (I’ve been on the sidelines with covid for almost a week–better now, though) from Albert Edwards, a perma-bear, Europe-based strategist, opining it feels like 36 years ago in world stock markets today.

my memory of 1987

1987 was my ninth year in the stock market and my third as a portfolio manager, after six years as a securities analyst.

Black Monday, when stocks in the US fell by 22% in one day and closed on their lows, was October 19th, 1987. It’s hard to communicate how big a shock this was. I’d spent the morning at my son’s nursery school before heading to work, so I missed a lot of the excitement. One of my work colleagues, though, was so shaken by the day’s decline that he had a panic attack on his way home, was hospitalized for an extended period and was unable to touch a portfolio again. Retail investors fared particularly badly, because overwhelmed brokerage offices were unable to field more than a fraction of their clients’ panicked sell orders. There were enough instances of irate customers shooting (yes, with guns) their brokers–or if not their broker, at least someone in the office–that guards at the front door were common for months after.

Four things, plus a note, that I think are essential to understanding what happened in back then:

–prior to the crash, 10-year Treasuries had been trading for months at around a 9% yield (the benchmark back then in the US was the 30-year, which was trading at 10%), while stocks were trading at 20x eps, or a 5% earnings yield (an academic measure, but still a useful rule of thumb, that tries to equate stock/bond valuation levels).  Just before the crash, the long Treasury, a less risky instrument than a stock, was producing guaranteed income that was almost double the implied “yield,” or return-as-a-share-of-company-earnings, that the holder of an S&P index fund would receive. This is a gigantic, and extremely unusual, valuation discrepancy. (Today, in contrast, the yield on long Treasuries is 4.8% and the earnings yield on the S&P 500 is about the same, implying both asset classes are in a similar valuation ballpark–the big flaw in the Edwards assessment.)

–the dollar was weakening against the yen and against European currencies, leading to fears that US interest rates might have to rise to keep foreign holders of Treasuries happy. That would be bad for any dollar-denominated investment

—dynamic hedging, something that’s a commonplace today, was in its infancy and being experimented with in the pension fund world.  The idea, formulated and executed by academics (usually a bad sign), is to enhance a portfolio’s value by wrapping it in an actively-traded layer of derivatives whose deft trading will reduce overall losses and enhance gains (deft-trading academics???). The deeper problem was that apparently everyone had assumed there’d always be in infinite stream of dumb money willing to take the other side of the trades. On the Friday before Black Monday, however, buying in the derivatives market dried up to the point where the dynamic hedgers–all/mostly market neophytes– were unable to sell stock index futures at theory-determined prices.  Over the weekend, they apparently decided that they were so far behind the curve they had to sell futures on Monday, even if the price were below what their theory required.

–in addition, early Monday morning before the open, at least one a major domestic pension fund (GM?) decided to sell a very large chunk of its stock holdings.

In the face of potentially massive selling in the cash market and in derivatives, buyers did what common sense would suggest. They disappeared, or became sellers themselves.

The result was chaos. Worst of all for retail investors, phone lines to brokers soon failed to function. Whether this was because they were overwhelmed or because brokers unplugged their phones is unclear.

—note: selling in the US quickly moved into the rest of the world. Many foreign markets at that time, especially less well-developed ones, had limits of, say, +/-5%, on how much a stock was allowed to rise or fall in a given day. The idea was that this would short-circuit any declines and give time for cooler heads to prevail. During the 1987 crash, this “protective” device had the opposite effect. After four days of limit down/no trade, a stock would end up being 20% lower and no one would have been able to sell a single share. This scared the wits out of people. Most affected exchanges quickly removed the limits and allowed prices to move down to the point where buyers emerged. There, order was quickly restored. For the few that didn’t, the ultimate declines were larger and the market disruption lasted longer.

As it turned out, the US stock market began to rally the following day. About six weeks later the indices returned to the lows, bounced off them and began to rise again–and the crisis was over.

I’ve started a new page for Keeping Score, because the old one was becoming too unwieldy.

The bottom line: not much of a mutual fund season so far this year, with time running out for one to develop.