For years I have believed, without analyzing it further, that the U.S. is experiencing a delayed economic downturn similar to Japan’s that started about 1990 and in many ways continues today. And that lessons from Japan’s difficulties and their attempts to improve conditions might be used to identify lower risk + higher return stock market ranking and selection methods for the U.S. market. In general, my belief is that there are many parallels in the economic, political, and social scenes and that it might be a fertile area to explore. Here I am not trying to look for a solution to the economic problems but trying to leverage lessons learned in the selection of stocks for investment purposes. As background, here is a Wikipedia article on Japan’s experience: Japan’s Lost Decade
The commonalities in my estimation include an aging population, an asset bubble, extremely low interest rates in an attempt to stimulate consumption and investment, increased savings rates, paying down debt by companies rather than expansion of debt (read lack of perceived market opportunities), consolidation by companies, loss of jobs and dilution of benefits, ballooning of government debt, low inflation, and so forth. You get the idea. Japan was unlucky enough to see a downturn earlier than many.
My question specifically is what type of Japanese companies have been able to grow profitably in that scenario, and might factors that would identify similar U.S. companies be likely to perform well going forward at this time? Thoughts anyone? For instance, would it be better to look for growth in sales and debt as an indicator of expanding potential, or already low debt, or specific situations that increase the chances of a merger, or? This is all speculation that there is a lesson to be learned, and I could be wrong about that.
As you say, it seems like Japanese companies took on too much debt and then could not reinvest for growth because their debt payments were too high (especially after the Japanese Central Bank raised rates). So maybe a combination of high ROE+low Dbt2Eq. Both together. My guess is that many Japanese firms pre-1989 had high ROE but it was fueled by debt, not efficiency (management excellence). So a screen for high ROE but low debt2Equity would be one way.
And any paper that just quotes Paul Krugman raises my doubts about its conclusions…
I think the other thing that happen in Japan is that it ran out of fresh ideas and energy. After WWII, they had a lot of people who needed to do something so they did not starve. They had little regulation about creating companies and they felt it was their duty to create wealth for Japan. So they worked hard, created stuff, listened to their customers and re-invested. Then, after 40 years, 2 generations, they ran out of gas. It happens. I think it is happening in Italy now too. Too many old people, not enough kids and not enough productive immigrants (uh,oh, I am starting to sound like Paul Krugman now…)
The topic of how to invest successfully during Japan’s lost decade has been studied. One way to have made money would be to buy the cheapest stocks. Value made money even during the lost decade.
BTW, while there might be similarities between Japan then and the U.S. now, Japan was much much more extreme.
As I recall, when I was growing up, the label “Made in Japan” provoked chuckles because it was associated with cheap garbage, often knock-offs. And even later when they became admired, much of that was based on efficient fancy internal production management, or to put it another way, an enhanced (through evolution up from garbage) version of “cheap.” They ran out of gas when they matured to the point where they needed to do something more than cheap, as occurred when other developing economies stepped in to undercut them.
A lesson is that cheap – cost efficient – is great, but only to a point. There are reasons why AAPL and others like it are U.S. companies. Even WMT and COST (cheap but innovatively so.) Culture matters too.
So what does that mean for us. For one thing, it means we can’t necessarily fear companies that don’t aim to compete on price. It also means we shouldn’t fear companies that do compete on price but are incredibly good at it. How do we balance two seemingly opposite considerations? Qualitatively, we can do it allover the place. Quantitatively, I always wind up coming back to good old ROE.
I did a quick test. I worked with ROA (to look at businesses only; i.e. ROE but controlled for different kinds of balance-sheet strategies). I also looked at companies with market caps above $10 bill. (I want established; smaller growing companies have additional sets of cultural considerations).
Screening on the basis of country (”jpn”)=1, I found the median figure for ROA%5YAvg to have been 2.55% and the average to have been 2.54% (N=25).
Screening on the basis of country (”jpn”)=0, I found the median figure for ROA%5YAvg to have been 4.91% and the average to have been 5.95% (N=634).
David thanks for pointing that out. EWJ and other index funds like EWZ have not done well in the last ten years but if SPY performs like EWJ in the future i don’t think many models will do well. Probably a new topic but how do we know when SPY is broken like EWJ? What should we prepare for? Trying to find companies that do well I think is like searching for a needle in a haystack. By the time you figure it out it might be to late.
Very true. I am not convinced that P123 will not be able to to sort through a few haystacks and even come up with some gems (also see Chaim’s post). That does not mean that I will be 100% invested.
If I am reading this right:
Inflation adjusted, the DOW was at 1906 on August, 1915. it went up and down a lot over the ensuing years. In Nov, 1949 it was at 1908.
So if you were unlucky and invested over the 34 year period from 1915 to 1949, you got zero by investing in blue chips. Scary.
In looking at the chart since then, there does not seem to be a time frame that was as catastrophic for investors over such a long time frame.
I don’t think the DOW was ‘broken’. There were just too many bad things that happened in the ensuing years. Like two world wars, a world wide influenza outbreak and other bad stuff. These were not asset bubbles like Japan but the result was the same. An ‘index’ did very poorly for effectively a generation and a half. So it can happen.
I personally don’t know of any way to protect against it. Just buying Gold has not really worked either. I guess you just have to be on your toes. The market did go up and down a lot over that 34 year time frame. So maybe people with a modicum of investing skill made money - not just lucky macro guys.
Pretty much. Japan had a peak CAPE in the 90s during the summer of 1990 when it crashed down to 35. It fluctuated between 25 and 40 between 1992 and 2002. Then spiked back up to the 70s-90s again before the financial crises.
In the US, we’re currently freaking out because it’s touching on 27. It approached 45 during the peak of the .com bubble. If I see CAPE above 35 in the SP500, I’m probably not going to be in US equities and looking elsewhere.
Regarding the statement “So if you were unlucky and invested over the 34 year period from 1915 to 1949, you got zero by investing in blue chips.”, don’t forget the dividends you would have been getting.
As I understand it, Japan has a declining population and hence deflation. America doesn’t have declining population but I heard on TV this morning that millenials make less than the previous generation. I assume this is the result of globalization and technology. This is the first time in modern history that this has happened. I speculate that wage deflation will ultimately lead to price deflation in the USA.
Some more food for thought …
Back in the 1990s something called the “Carry Trade” came about, essentially a huge arbitrage trade shorting the Yen while buying the USD or other high yielding currency. Today we have a version of this… While shorting the Yen remains, the opposite side of the trade buys US Treasuries or US stocks. This explains why we have such “high” valuations in stocks and a bubble in treasuries. With massive debts and abenomics there is no chance of a rising Yen unless the rest of the world suddenly collapses, USA included. This is such a significant play (US treasuries long / Yen short) that it impairs Federal Reserve monetary policy. The Fed can raise the low end of interest rates, and the high end may respond temporarily, but the end result may be that the upper end is pinned. Thus raising interest rates in the USA could invert the yield.
Ultimately, the only solution I can think of for tackling world debt is to have all of the central banks conspire to set interest rates at zero, and allow governments to devise plans to pay down their debts over the next 50 years. That only works if every government sticks to the plan (which is doubtful). It means an end to monetary policy, and allowing currencies to vary however they must vary in a free economy (which we don’t have now).
