Japan's Lost Decades in One Chart

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berntson
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Japan's Lost Decades in One Chart

Post by berntson »

Japan's stock market crash is often presented as an example of the terrible returns that stock investors could experience at any time. I've made this point before in other places, but Japan's two decades of lousy returns followed one of the largest stock bubbles the world has ever seen. Their crash and subsequent lost decades was neither surprising nor unavoidable.

I recently ran into a chart that nicely illustrates this point. It's from Meb Faber's book on global value. The x axis is months and the y axis is PE10. The chart shows the run-up to the Japanese bubble and the US tech bubble and the number of months it too to return to pre-bubble valuations.

Image

Japanese stocks were more than twice as expensive at their peak as US stocks at the peak of the tech bubble. Japanese stocks continued to be overvalued even after their crash in the early 1990s. Given that valuations never really returned to normal, until recently, it's not surprising that Japanese returns have been lackluster. No one should think that they can buy a broad index with a PE10 of nearly 100 and make money.
livesoft
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Re: Japan's Lost Decades in One Chart

Post by livesoft »

So are you recommending that folks buy now based on the chart?

It would not hurt to add labels to the X and Y axes though even though you named them in your text.
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whaleknives
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Re: Japan's Lost Decades in One Chart

Post by whaleknives »

Why does the U.S. data stop 10 years before Japan's?
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bertilak
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Re: Japan's Lost Decades in One Chart

Post by bertilak »

whaleknives wrote:Why does the U.S. data stop 10 years before Japan's?
I expect the US data stops shortly before the date the chart was made.

The two plots do not line up at the same years, but at the point where the CAPE ratios peaked. It just hasn't been that long for the US.

At least that's how I read the chart.
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Re: Japan's Lost Decades in One Chart

Post by steve_14 »

As I noted in a different thread, Japanese accounting standards result in ratios that are not comparable to those of the US (I remember seeing somewhere P/Es are about double what they would be under US standards).

FF/DFA and co will tell you that it's price to book, not price to earnings that best determine future stock returns. The P/B for Japanese small caps was 1.2 in 2001 vs 4.5 for UK small caps. But Japanese P/Es were higher. So which one was cheap?
staythecourse
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Re: Japan's Lost Decades in One Chart

Post by staythecourse »

Forget about complicated charts to make one's point.

Can't remember if it was Robert T or someone else who had an link to an excellent DFA slide presentation looking at 100 yrs. of stocks, bonds, bill returns globally from Dimson Marsh data. In that slide presentation it showed that the worst 5 streaks for single country stock returns in the 100 yrs. of data (obviously Japan included) had bond and bill returns with much longer draughts during those same time periods and longer time to get back to "even". The learning point: When single country stocks it a LONG dry spell don't expect a bond or cash heavy investor to do any better. When country's markets go down the tubes what do you think fiat currency policies would be? They lower short term interest rates thus lowering bond and bill returns as well. So it makes sense.

Good luck.
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plats
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Re: Japan's Lost Decades in One Chart

Post by plats »

whaleknives wrote:Why does the U.S. data stop 10 years before Japan's?
My take: Japan's peak was ten years before the USA's. The ends of the lines are both current to about a year or so ago.
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Cut-Throat
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Re: Japan's Lost Decades in One Chart

Post by Cut-Throat »

staythecourse wrote: The learning point: When single country stocks it a LONG dry spell don't expect a bond or cash heavy investor to do any better.
Yeah but the bond and cash heavy investor didn't lose as much in the crash as the stock investor did.

The learning point : Having Bonds and Cash is not about making money, it's about not losing it!
Clive
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Re: Japan's Lost Decades in One Chart

Post by Clive »

In the 1980's Japan's economy was rising strongly, heading towards and reaching becoming the world dominant economy.

Image

Many indexes are market cap weighted - weighting larger companies more heavily than smaller companies. A problem with that is a very large/too-big-to-fail company, can still be relatively large after its taken a 50% or more hit. It can takes years for some of those losses to be recouped. With more equal weighted or smaller (mid cap, small cap) indexes alternative stocks can more readily step up to replace relatively poorly performing stocks i.e. bad blood/failures replaced more quickly rather than sitting around waiting for a single stock to make a recovery.

Image

We're seeing somewhat similar effects in the UK in more recent times. FT100 (largest UK 100 stocks) has significantly lagged the FT250 (next 250 largest) in recent years. Pre 2008 the FT100 was quite heavily weighted towards large financial stocks (banks) and whilst still relatively large, they're nowhere near former levels (at least not yet). Whilst the broader market (more equal weighted index) i.e. FT250 is moving along quite nicely.

The Wall Street Crash years were prefixed with the "Roaring 20's", i.e. sometimes things get (very) ahead of themselves, correct back down and can take a long time to reach back up to former high levels.

Image
staythecourse
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Re: Japan's Lost Decades in One Chart

Post by staythecourse »

Cut-Throat wrote:
staythecourse wrote: The learning point: When single country stocks it a LONG dry spell don't expect a bond or cash heavy investor to do any better.
Yeah but the bond and cash heavy investor didn't lose as much in the crash as the stock investor did.

The learning point : Having Bonds and Cash is not about making money, it's about not losing it!
Maybe or maybe not. It took the fixed income investor LONGER to break even as the draughts were much longer then the stock investor. So if your in accumulation it likely made it worse.

Don't want to steal the thread, but if someone has the link it would be great to re-analyze it and the meaning of the results in both accumulation and deaccumulation.

Good luck.
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Cut-Throat
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Re: Japan's Lost Decades in One Chart

Post by Cut-Throat »

staythecourse wrote: Maybe or maybe not. It took the fixed income investor LONGER to break even as the draughts were much longer then the stock investor. So if your in accumulation it likely made it worse.

Don't want to steal the thread, but if someone has the link it would be great to re-analyze it and the meaning of the results in both accumulation and deaccumulation.
You're missing the point!..... The high percentage portfolio Fixed Income Investors should be in retirement. They aren't looking to break even. They are spending down their portfolios. In the Time Frame you are talking about they're dead.

So, I agree if they have time, they should be invested in a High Percentage Stock Portfolio. But, if they are retired, they need to be a Bond Heavy Investor... Time is no longer on their side..... They're in the 4th quarter.
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nedsaid
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Re: Japan's Lost Decades in One Chart

Post by nedsaid »

Japan is an excellent example of why an investor should diversify internationally. One should note that while Japan was experiencing bust in the 1990's, the US Stock Market was booming. Another thing to note was that Japan had overinvested and thus had too much slack capacity in its economy. I believe China is doing the same thing, building for export demand that may never materialize. In other words, the increase in productive capability may not be matched by increased demand for products and services. As I recall, Japan was very slow to write off bad loans which seems to be happening in China now.

Steve_14 raised an excellent point which is the difference in accounting standards. When we compare numbers we should do our best to compare apples to apples. I have to admit my ignorance of Japanese accounting standards, I would like to see a source for his assertion that different accounting standards caused Japanese P/E's to be twice as high as if they had been using American accounting standards. The trend is towards International Accounting Standards. He did raise an interesting point.
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Re: Japan's Lost Decades in One Chart

Post by Clive »

nedsaid wrote:Japan is an excellent example of why an investor should diversify internationally. One should note that while Japan was experiencing bust in the 1990's, the US Stock Market was booming.
To paint a more artful than scientific picture - whilst US stock total gains doubled in nominal terms 1990 - 1995, the Yen relatively doubled. J-Inflation was around 10% in total over those 6 years. J-T-Bonds gained something like 65% to 70% in total.

Broadly, from a Japanese investors perspective it looks something like (first half of 1990's) : domestic stocks down a lot (-40%), foreign stocks (US) near break-even (up in US$ terms, but those gains negated by strengthening Yen), bonds up a reasonable amount (+65%), in nominal terms over a period that had 10% inflation (in total). A three fund equal amounts of domestic stocks, US stocks, bonds wouldn't have been much different to 50/50 domestic stocks/bonds, both producing rewards similar to inflation i.e. 0% real over the 6 years (but with zigzagging around that during interim periods). Both of those however were better than 66/34 domestic stocks/bonds.

Bonds did well primarily due to cash interest rates dropping from 8% down to 1% over 1990 to 1996 (i.e. capital gains as yields declined). Inflation rate dropped from 4% to near 0%.

Japan zigzagged sideways in the late 1990's and then ran into the world dot.com bubble bursting - dragging its market down in a similar manner to the US/UK etc up to around 2003/4. It then started a recovery - and ran into the 2008/2009 financial crisis and dived back down as per the US/UK. Started to recover again and then ran into the Fukushima Accident 2011 nuclear accident event. Since late 2012 to mid 2013 its again recovered somewhat (near doubled) - and sideways zigzagged since. i.e. a series of unfortunate events - some domestic, some global. Global diversification helps to mitigate domestic risks.
Last edited by Clive on Sat Jul 19, 2014 7:08 pm, edited 1 time in total.
staythecourse
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Re: Japan's Lost Decades in One Chart

Post by staythecourse »

Cut-Throat wrote:You're missing the point!..... The high percentage portfolio Fixed Income Investors should be in retirement. They aren't looking to break even. They are spending down their portfolios. In the Time Frame you are talking about they're dead.
I agree with that, but the issue then becomes why doesn't everyone just get a SPIA and call it quits? I am not in retirement so I don't understand that aspect. To me it seems folks are keeping one foot in and one foot out of the deep end (preservation and still trying to grow capital).

So if folks have enough, i.e. won the game why are they invested in stocks at all? Why not all in TIPS for example.

Good luck.
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White Coat Investor
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Re: Japan's Lost Decades in One Chart

Post by White Coat Investor »

Clive wrote: Image
The Japan Trajectory looks a lot better to me than the Russian one.
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Cut-Throat
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Re: Japan's Lost Decades in One Chart

Post by Cut-Throat »

staythecourse wrote:I agree with that, but the issue then becomes why doesn't everyone just get a SPIA and call it quits? I am not in retirement so I don't understand that aspect. To me it seems folks are keeping one foot in and one foot out of the deep end (preservation and still trying to grow capital).

So if folks have enough, i.e. won the game why are they invested in stocks at all? Why not all in TIPS for example.

Good luck.
Well, in essence folks are keeping 'one foot in and one foot out of the deep end'.... that's what asset allocation is all about. The Problem with SPIA's is that they don't protect against inflation (Which may not be a big deal if you are in your 80s). And if you are start shopping for an SPIA that does have inflation protection and 100% Spouse Protection, you'll find the withdrawal rates well under 4%. And then there is the 'Trusting in Insurance Companies thing (Which I believe are basically evil). And then TIPs which used to be a good deal at 2%, are not that great anymore.

So, us retirees set our asset allocations to 30% Stocks and 70% Bonds and rely on 100 years of history and 'Staythecourse'. If you understand the downside to this approach, it's not that foreboding.
Last edited by Cut-Throat on Sat Jul 19, 2014 7:27 pm, edited 1 time in total.
Clive
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Re: Japan's Lost Decades in One Chart

Post by Clive »

staythecourse wrote:So if folks have enough, i.e. won the game why are they invested in stocks at all? Why not all in TIPS for example.
Concentration risk. What if inflation spikes to 16% yearly, TIPS yield 16%, but are taxed at a 25% rate = -4% real, less perhaps 3% withdrawals for living expenses = -7% yearly. If that inflation persists for a handful of years, then with less capital each year and increasing amounts needing to be drawn for living expenses you could see half of total wealth or more disappear relatively quickly.

If after a handful of years you're down at 50% of former levels and needing to withdraw 6% to sustain former levels of spending/living expenses ..... perhaps after just over a decade of retirement and your retirement preparations/plan is wiped out.

UK % yearly inflation 1973 - 1981 inclusive
10.6, 19.1, 24.9, 15.1, 12.1, 8.4, 17.2 15.1, 12

UK 1915 - 1920
23.6, 18.5, 20.9, 15.2, 2.3, 19.6
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JoMoney
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Re: Japan's Lost Decades in One Chart

Post by JoMoney »

nedsaid wrote:... I would like to see a source for his assertion that different accounting standards caused Japanese P/E's to be twice as high as if they had been using American accounting standards.
Here's one report by Ken French:
http://www.nber.org/papers/w3290
... The difference between reported price-earnings ratios in the United States and Japan is not as puzzling as it appears at first glance. Nearly half the disparity is caused by differences in accounting practices with respect to consolidation of earnings from subsidiaries and depreciation of fixed assets. If Japanese firms used U.S. accounting rules, we estimate that the P/E ratio for the Tokyo Stock Exchange would have been 32.1, not the reported 54.3, at the end of 1988. Accounting differences are unable, however, to explain the sharp rise in the Japanese stock market during the mid-1980s. ...
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Re: Japan's Lost Decades in One Chart

Post by Karamatsu »

I really don't think there's a lot to be learned with simplistic graphs of price or PE. Placing two lines on a graph like that ignores huge contextual differences between the ways equities are used in the two countries, and the the ways they were used in different time periods even within the same country. The conclusions are only as good as the errors inherent in the assumption that nothing else matters.

All in all I wonder if it isn't just a desperate way to try to convince ourselves that "it couldn't happen here," when we all know, or at least suspect, that with the right political/economic conditions, it could.
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Re: Japan's Lost Decades in One Chart

Post by Clive »

"it couldn't happen here," when we all know, or at least suspect, that with the right political/economic conditions, it could
And the answer is to diversify to reduce risk/impact - up to a point. TIPS, bonds, stocks ... etc have all had periods when they failed to reward sufficiently/as-expected. Being heavily weighted in any one across such a 'failure' period, where a failure needn't be total, can heavily impact the investor. Whilst a asset may appear to have performed ok in nominal terms, after you adjust for inflation and taxation the picture might be totally different.

Diversification however is often wrongly assumed. 33% domestic stocks, 33% foreign stocks is still 66% stocks. Better to diversify across human capital (education, wages, pension), a home (roof over your head such that even if the value of that home might have crashed, you still get to live there rent free (imputed income)) and stocks/bonds/liquid assets. If you own a home (roof over head), have a state/private pension that covers basic living expenses, and some stocks/bonds then you're more protected than if you had no pension, no home (rented) and invested everything in stocks expecting the rewards from such to provide a roof over your head and sufficient income to cover basic living expenses consistently for perhaps 30+ years. Once you have those core diverse holdings (a roof over your head/basic living expenses covered) any surplus can be invested in single/concentrated choices if so preferred. 100% stocks for such surplus amounts is just as acceptable as 100% TIPS.

$400K home that would otherwise cost $20K/year to rent.
$20K state/private preferably inflation linked pension
$20K x 20 years in a TIPS ladder with the intent to drawdown

... and assuming you can get by on $40K/year disposable you're reasonably safe. If your total wealth is $3M with $400K in home value, $400K (initially) in a TIPS ladder and $2.2M in stocks that is acceptable, even for a 70 year old, despite possibly being measured by some as being $2.2M stocks/$400K TIPS (85% stock/15% bonds).
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Re: Japan's Lost Decades in One Chart

Post by nedsaid »

Clive, you raised a great point about currencies. This has been talked about on other threads. Because of YEN appreciation and very low inflation if not a mild deflation, the Japanese investor did not fare as badly as what is perceived here. I am still a believer in international diversification. By owning International Stock funds, one also gets currency diversification.
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Re: Japan's Lost Decades in One Chart

Post by Clive »

nedsaid wrote:Clive, you raised a great point about currencies. This has been talked about on other threads. Because of YEN appreciation and very low inflation if not a mild deflation, the Japanese investor did not fare as badly as what is perceived here. I am still a believer in international diversification. By owning International Stock funds, one also gets currency diversification.
Over the 2008/9 financial crisis period, McDonalds held up reasonably well as it has matched liabilities in many countries (both debts and credits (profits)). The UK FT100 index (largest 100 companies) had something like 70% of its earnings derived from foreign business - yet despite the GB£ declining a lot it still fell a lot. That is perhaps indicative that many companies hedge their foreign currency risk - as they report in GB£ they seek to reduce currency risk. Such detail goes unreported, so you just don't know whether a stock hedges currency risks or not. Holding foreign stocks directly, such as a UK investor holding BRK during 2008/9 and whilst BRK dropped more or less the same as the broader US market, in GB£ terms the benefit of holding BRK in US$ was a near cancellation of stock price declines.

Of course things could work the other way as you're exposed to stock risk/reward +/- FX risk/reward. If foreign stocks drop and the domestic currency gains in strength then you have a double-whammy loss.

You have to be careful of what a international stock fund actually holds and what FX hedging may be contained with that. Personally I prefer to manage such aspects more directly myself. For example the likes of the UK version of TD Ameritrade (TD Direct Investing) allows investors to hold multiple currencies in the same account and to trade in any one of around 15 different markets. You convert currency as you see fit, and then can buy/sell stocks using that currency (use US$'s to buy US stocks, sell US stocks back into US$, or CAD$/stocks, or ...etc.).

Another factor is that some countries (many) impose withholding taxes against dividends. Funds might absorb such costs and additionally charge a management fee. Those combined costs can be quite high, depending upon the level of withholding tax, how much dividends are paid, whether reclaimable or not ...etc. Again I prefer to manage that aspect myself (if high dividend withholding taxes that can't be offset/reclaimed, then look to hold stocks that pay relatively small/no dividends). BRK is such an example (holds many stocks itself, so a form of US index type stock that pays no dividends so no US 30% withholding taxes apply). Hong Kong in contrast has no withholding taxes and pegs its currency to US$, whilst some stocks pay reasonable dividend yields....etc.

The FX markets are a lot bigger and more pure. I'm all for holding international stock exposure as I've enough domestic exposure via other assets (bonds, properties etc.). Some of the biggest players around are more in tune with FX than with individual stocks/asset performance. Even holding relatively stable assets in 'domestic' (foreign) currencies can have wild volatility once FX is also accounted for. For example from a UK investors perspective US$ BIL (T-Bills)

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Re: Japan's Lost Decades in One Chart

Post by nedsaid »

It shouldn't surprise me that multi-national companies hedge against currency risk. It is honestly something that I haven't given much thought to. Airlines hedge their fuel costs with futures. Food companies buy commodity futures for the same reason. I just figured that over the long term that all the currency fluctuations would even themselves out.

My approach to International investing isn't really all that sophisticated. It just makes sense to me to spread your investments across many countries rather than your own. I want to own stocks all over the world. Since purchasing power exists in other forms than the US Dollar, it seems prudent to have currency diversification as well. As far as I know, the International Stock funds that I own do not hedge out currency risk.

Clive, I know what you are saying about the foreign taxes on dividends. I own shares of Tim Horton's in a taxable DRIP account, probably the best known and best loved restaurant chain in Canada. Being a US Investor, I claim a foreign tax credit on my US tax return. But this is a thing to consider as most of my International Stock funds are held in tax-deferred retirement accounts, the taxes paid on the dividends on stocks in those accounts are a drag on returns since I cannot claim the tax credit.

The only time I play the currency markets is when I buy foreign currencies for my international travel. So I have spent in Yen, Canadian Dollars, Euros, British Pounds, Czech Crowns, and Hungarian Forints. But in my investments, I have bought my International Stock and Bond funds and let the currencies fluctuate as they may. Sometimes the currency exposure helps me, sometimes it is a drag on returns.

Your experience with TD Direct Investing in the UK is very interesting, being able to buy foreign securities in their own currency. I suppose I could do this in the United States. I am not sure if I could hold my retirement account assets in anything other than what is denominated in US Dollars. But this is more than what I want to take on.

If I were a much wealthier person, I probably would consider owning foreign currencies. I don't do this now except indirectly through the International Stock and International Bond funds that I own.

Thanks Clive. You have brought up some good issues that I haven't given much thought to.
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Re: Japan's Lost Decades in One Chart

Post by Clive »

nedsaid wrote:I just figured that over the long term that all the currency fluctuations would even themselves out.
Broadly they do (some up/others down) - except if the domestic currency collapses in isolation.

I don't do anything particularly clever with currencies, just normal rebalancing stuff. 2009 reduce US stock, add to domestic (UK) stock - primarily due to US stocks in GB£ having remained more or less level after accounting for £/$. More recently reducing UK stock to buy US stock due to relatively strengthening £. Broadly US stocks and UK stocks tend to follow similar motions such that on the stock side of things it doesn't matter that much if you hold one or the other.

Mix FX all into one so that its effects are neutral overall and you're less inclined to exploit individual FX swings.
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