What exactly happened in Japan...and can it happen here?

[El Greco]

Inquiring Bogleheads want to know:

I'm very fuzzy about why the Japanese market took a huge dive and stayed down for so many years. Can some of the pundits on this board explain it simply? The "Japan" situation is usually used as a rationale for maintaining a significant amount of international diversification, but I never have quite understood what caused that situation to occur. And of course, the second part of the question. Could a similar scenario happen in the US?

[edge]

This isn't some deep mystery. There were multiple factors. In my opinion the most fundamental aspect of the crisis and following 'lost 20 years' was the post-bubble persistent lack of confidence in the economy on the consumer side.

https://en.wikipedia.org/wiki/Lost_Decade_(Japan)

I am not sure if the same could happen in the US. Some of Japan's reaction to the bubble was cultural.

[TomCat96]

Inquiring Bogleheads want to know:

I'm very fuzzy about why the Japanese market took a huge dive and stayed down for so many years. Can some of the pundits on this board explain it simply? The "Japan" situation is usually used as a rationale for maintaining a significant amount of international diversification, but I never have quite understood what caused that situation to occur. And of course, the second part of the question. Could a similar scenario happen in the US?

I've tried to look into this as well. As far as I can tell exactly what happened and the lessons to be taken from it is still a matter of some debate.
Nevertheless

https://en.wikipedia.org/wiki/Lost_Decade_(Japan)
https://en.wikipedia.org/wiki/Japanese_ ... ice_bubble

This is my personal interpretation.

1) Japan had an asset bubble in their real estate of staggering proportions and at some point that had to pop. By staggering proportions, here are some examples.
--some prime property in Tokyo slumped to 1% of its peak price.
--It was said at the time that the value of the Imperial Palace in Tokyo exceeded the value of all the real-estate in California.

2) Housing propagates throughout the economy like no other asset class. In a broad sense, EVERYONE is exposed to property assets.
--High property prices in area will change the prices of properties in neighboring areas, reallocating capital at those high prices.
--Banks who lend have their credits paralyzed
--to the extent that mortgages based on bubble valuations are securitized, the exposure to those properties will be propagated to other seemingly
uncorrelated asset classes.
--to the extent that bubble valued properties are used directly or indirectly to secure credit (collateral for example), the exposure will be further
propagted.

3) Combined with Japan's low birth rate, which was likely exacerbated by the difficult economic conditions in Japan, inflation has remained non-existent. In fact Japan has experienced prolonged deflation.


Now here's the bit of logic often cited which makes no sense to me.

Common Boglehead argument #1
============================================
1. Japan crashed.
2. If you were Japanese, you would have wanted to invest abroad, like in America.
Therefore.
3. If you live in America,
4. You should invest abroad, because the same thing could happen here.

I disagree with that rationale. It's shaky, and there are different ways of processing the information.
Here is another rationale sometimes cited.

Common Boglehead argument #2
============================================
1. World Global Markets are efficient allocators of capital.
2. You should allocate your money in accordance with the way global capital has been allocated to capture that efficiency.
3. ergo, invest your money in international stocks. (something like half US, half international.)


Now for Tomcat96's argument, which very few seem to agree with.

1. US markets are simply superior.
--the continued effects of global corruption, misallocated exposures, inexperience with economics, lesser economic instability,
weaker sovereign currencies, lesser military stability, lesser government stability, weaker government laws on property protection,
poorer tort and compensation systems, less capitalistic systems, higher levels of sovereign debt, and VAT tax systems all lead to me to believe
that for now, US markets are simply superior.



Now to answer OPs question, can it happen here?
Yes what happened in Japan can happen here. But not any time soon. Why not?

1. Our property bubble at its worst was nowhere near the relative stupidity of Japan's market. Properties may be have dropped by 30-40% They didn't drop 99%. Credit is also hard to obtain. This means less leverage and exposure.

2. Our sovereign debt that we issue doesn't get used to finance a carry trade.

3. Our population is ever growing. We have stronger inflationary forces than Japan.

4. ergo, our property prices are fine. We had a decade of property price stagnation, but also a decade of population growth, and a decade of savings.

5. To the extent that foreign money entering our property market has spiked prices, the propagation of this money into these properties to cause an asset bubble will be more limited because
5a) they are constrained to cities
5b) foreign buyers pay cash. No mortgages.


For now, I don't believe what happened in Japan will happen here. We lack the exposure, and the asset prices for now. Frankly our valuations, for all asset classes, are too reasonable at the moment.

[randomguy]

This isn't some deep mystery. There were multiple factors. In my opinion the most fundamental aspect of the crisis and following 'lost 20 years' was the post-bubble persistent lack of confidence in the economy on the consumer side.

https://en.wikipedia.org/wiki/Lost_Decade_(Japan)

I am not sure if the same could happen in the US. Some of Japan's reaction to the bubble was cultural.

Pretty much happened in the US. Look at the great depression where you had 4x run up over a half dozen years (like Japan) followed by a decade of doing nothing. Difference is the US economy had a big war and the rebuild afterwards to get things going.


Going forward it is hard to figure out if stuff like this (great depression, japan lost 20 years, 70s stagflation,...) can happen again. You would like to think that we learn and that we have a better handle on how to use the government to manipulate the economy. But we have no way of knowing. Maybe the great recession should have turned into a depression but because of the stimulus it didn't. Or maybe the stimulus made no difference. Or maybe it needed to be 2x as big to not have a stagnant rebound. You can make some educated guesses but they are just guesses.

History rarely repeats itself. At somepoint we will have some economic crisis but the cause is likely to be something different than the last one. Everyone seems to expect another national level real estate bust because that is what caused the last crisis or a sector meltdown like the dot.com bust (previous crisis). Personally I think we get something unrelated. But who the heck knows what that will be.

[warowits]

This isn't some deep mystery. There were multiple factors. In my opinion the most fundamental aspect of the crisis and following 'lost 20 years' was the post-bubble persistent lack of confidence in the economy on the consumer side.

https://en.wikipedia.org/wiki/Lost_Decade_(Japan)

I am not sure if the same could happen in the US. Some of Japan's reaction to the bubble was cultural.

Link above isn't working, just click through to the suggested article.


I for one am glad here in the US we don't bail out failed banks or other companies that are 'too big to fail', so we don't have to worry about this ever happening...

[lack_ey]

The serious argument isn't that the US might have a repeat of Japan; as explained above there are just so many differences in the circumstances that it seems very unlikely that a "similar scenario" to that extent could happen in the US any time soon.* The Japan example is just a lazy shorthand (one that I've used sometimes, because am lazy) for calling to mind one extreme example that illustrates what can go wrong, to make a certain point. There are many other countries in which some diversification outside would have materially helped.

*Note that a milder result simply of diverging returns is not unlikely at all. Past 5-yr US stock return is 14.4% annualized in nominal terms, while for ex-US it's 4.5%. If you don't think this can just as well flip in the next 5 years or even more, you're delusional.


Some like TomCat96, Warren Buffett, and John Bogle attribute relative US market stability, high returns, and success to conditions unique to the US. Or perhaps if not unique, far from universal elsewhere. I think they have something of a point, to be honest, but in general I don't put very much stock into qualitative analyses and rationalizations, even though they may contain some or a lot of truth. It's just hard to know how much of a story is actually true or not, particularly when they confirm to your biases.

When unsure I would err on the side of diversification out of a position of ignorance, enough that I think that owning ex-US stock is worth the penalty of the additional cost and taxes. In general, the stronger your "read" and the benefit from being right in the context of the downside of being wrong, the more you should bet on a narrower result. You have to run the cost-benefit analysis for yourself based on what you believe.

[Dutch]

I believe demographics is the reason it's continuing to happen in Japan

[KlangFool]

OP,

I do not like to put all my eggs in one basket.

1) I invest in US total market index fund.

2) I invest in International index fund.

3) I invest in the total bond market index fund.

4) I invest in Wellington fund (world oldest mutual fund -> active managed)

5) I keep 1 year worth of emergency fund.

6) I bought a house with 30 years fixed mortgage as an inflation hedge.

7) I keep some amount of cash at home.

8) I have some amount of gold jewelry.

I cover all my bases. So, I do not worry and think about whether X can happen.

KlangFool

[Index Fan]

^ A wise man ^

[protagonist]

Of course it can happen here.

Anything can happen anywhere. You can come up with countless rationalizations and logical arguments to support a contrary opinion , but at the end of the day.....

The future is unknown.

And the probability of its occurrence over, say, a 20, 30 or 50 year time frame is also unknown, since , even if you believe that the future is predictable based on past events, there is simply not enough history to make any statistically valid predictions.

[Bertie]

I doubt if the US stock market would experience the same sort of failure that the Japanese stock market did in the 1980s. The US market structure is different than the Japanese market was at that time.

The Japanese had a “keiretsu” system, where various companies and banks had interlocking relationships and held shares in each other. They had a form of cross-ownership, in other words, although typically they had limited control over each other. This worked very well while their economy was booming – a rising tide lifts all boats – but when the economy faltered, the effect of this cross-ownership accelerated the decline of stock prices.

One of the reasons is during the bubble some companies reported capital gains on stocks as profits on their corporate financial statement. So these companies looked more profitable than they actually were. Of course when the stock market crashed, they started reporting capital losses. So even if their underlying business was decent, these capital losses made their operations look worse than they actually were, hence the decline in stock prices. This is a simplification, but a lot of the Japanese stock market crash was caused by financial engineering. And it was the structure of that financial engineering — how companies had organized themselves and their finances — that made stock price recovery so difficult.

Of course there’s financial engineering in the US markets, too, but it takes different forms, and isn’t nearly as extensive and pervasive as what Japan experienced in the 1980s. We could easily have a persistent decline and plateau in stock prices (we certainly did from the late 60’s to early 80’s), but it’ll probably be for different reasons than what caused Japan’s decline.

[AlohaJoe]

4) I invest in Wellington fund (world oldest mutual fund -> active managed)

FWIW, Wellington isn't the oldest; MITTX (Massachusetts Investors Trust) is older by several years. It looks like Wellington is the 5th oldest: http://www.investopedia.com/ask/answers ... lfunds.asp

That list makes me think that "age of mutual fund" might not be a good barometer, since I'm not sure I'd want to in many of the ones there!

[bhsince87]

What happened in Japan wasn't a total disaster. If an investor who lived in Japan was totally invested in Japanese bonds and stocks, and only spent money inside Japan, they haven't suffered much at all.

I've got many friends in Japan. And most of them are perfectly comfortable.

Yes, their investments didn't grow much. The stock market was flat for a long time. But most analysis of Japan doesn't consider the income from dividends and interest, and the positive impact of deflation on the average person's purchasing power.

[KlangFool]

4) I invest in Wellington fund (world oldest mutual fund -> active managed)

FWIW, Wellington isn't the oldest; MITTX (Massachusetts Investors Trust) is older by several years. It looks like Wellington is the 5th oldest: http://www.investopedia.com/ask/answers ... lfunds.asp

That list makes me think that "age of mutual fund" might not be a good barometer, since I'm not sure I'd want to in many of the ones there!

AlohaJoe,

Fine. I will stick with my Wellington fund and you can pick something else. The point is I choose an actively managed fund too just to be safe.

KlangFool

[basspond]

Interest rates below 1%. Going below that threshold kicks of a lot of negative head winds(unwilliness to raise rates because the effect on national debt, investors can't make any money on "safe" investments, destroys confidence, any increase will see money flow out of equities, higher risks leaves more skittish markets). There has to be a cost for money.

But then again it could be the emergence of China.

[Valuethinker]

Inquiring Bogleheads want to know:

I'm very fuzzy about why the Japanese market took a huge dive and stayed down for so many years. Can some of the pundits on this board explain it simply? The "Japan" situation is usually used as a rationale for maintaining a significant amount of international diversification, but I never have quite understood what caused that situation to occur. And of course, the second part of the question. Could a similar scenario happen in the US?

As part of a giant real estate-stock bubble:

1. Japanese market was at PE of 40-50x +. Lots of arguments at the time as to why this was not abnormal, not strictly comparable to PEs of other markets. In other words, exactly what Shiller talks about re bubbles, a willingness to invent new explanations to justify them.

2. Dividend yield on the market was less than 1.0%

3. Japanese households and companies had all become stock speculators. I can't remember exact numbers, but something like 30% of Japanese profits from *non financial* companies came from financial trading (buying and selling stocks in other companies, etc.)

4. RE market bubble was clear in retrospect . Land under Imperial Palace worth more than all the land in California, etc.

The slump was inevitable once the bubble burst but was exacerbated by:

- Central Bank lagged the curve the whole way. Was slow to bring down interest rates. So was the government slow to take action, and was humstring by Japanese politics (the governing LDP Party is strong in rural areas, and heavily involved with the corrupt construction industry, and so directed huge investment towards pointless bits of concrete in the countryside).

Japan was in unprecedented and unknown territory, and actually hasn't done too badly given the dimensions of the crisis-- no one had been in this situation before. We can criticize them, but our 2008 actions (which were informed by the Japanese example) have also not fully met the test.

- "Zombie companies" and "zombie banks". Because of the way Japanese politics and economics works, the country was very slow to write down and write off the overvalued assets, and kept companies and financial institutions alive for years after they would have gone bankrupt under another system

- changing demographics-- Japan has the oldest, and the first shrinking, population in the developed world, and minimal (legal) immigration

[Valuethinker]

Inquiring Bogleheads want to know:

I'm very fuzzy about why the Japanese market took a huge dive and stayed down for so many years. Can some of the pundits on this board explain it simply? The "Japan" situation is usually used as a rationale for maintaining a significant amount of international diversification, but I never have quite understood what caused that situation to occur. And of course, the second part of the question. Could a similar scenario happen in the US?

Re USA

Yes of course it could. A dramatic stock bubble and dot com crash in 2000-03 led to monetary measures and regulatory laxness which led to a housing bubble and collapse followed by the slowest post recession growth of any period since the 1930s. Policy mistakes compounded that, probably, due to particular political characteristics of the US system.

However the US has positive demographics (birth rate and immigration) and by the nature of its people and country is geared towards rapid change, writing down, writing off and moving forward. Consider the shale drilling boom, which is really (as a big effect) entirely post 2000-- there's rapid technology change for you in spades.

It's unlikely the US story would play out exactly in the way the Japanese one did. But stagnation is certainly possible.

[Valuethinker]

I doubt if the US stock market would experience the same sort of failure that the Japanese stock market did in the 1980s. The US market structure is different than the Japanese market was at that time.

The Japanese had a “keiretsu” system, where various companies and banks had interlocking relationships and held shares in each other. They had a form of cross-ownership, in other words, although typically they had limited control over each other. This worked very well while their economy was booming – a rising tide lifts all boats – but when the economy faltered, the effect of this cross-ownership accelerated the decline of stock prices.

One of the reasons is during the bubble some companies reported capital gains on stocks as profits on their corporate financial statement. So these companies looked more profitable than they actually were. Of course when the stock market crashed, they started reporting capital losses. So even if their underlying business was decent, these capital losses made their operations look worse than they actually were, hence the decline in stock prices. This is a simplification, but a lot of the Japanese stock market crash was caused by financial engineering. And it was the structure of that financial engineering — how companies had organized themselves and their finances — that made stock price recovery so difficult.

Of course there’s financial engineering in the US markets, too, but it takes different forms, and isn’t nearly as extensive and pervasive as what Japan experienced in the 1980s. We could easily have a persistent decline and plateau in stock prices (we certainly did from the late 60’s to early 80’s), but it’ll probably be for different reasons than what caused Japan’s decline.

This is all very helpful insight and a well written explanation.

Thank you.

I can't remember the Japanese word for it, zeiteku? Something about profits from financial engineering (in non financial companies).

Arguably, pre 2008, *within the financial services industry*, the US got to a somewhat similar level of inflated profits. Just as the very high stock prices during the dot com bubble allowed the tech & telecom industry to spend far more money, thus inflating its own profits.

In both cases though, the effect was more localized.

[BrklynMike]

Charlie Munger has written about this issue as a warning to US financial markets. He claims the recession in Jaoan was due in large part, as previous posters have noted, to a corporate corruption combined with a culture of not questioning authority/superiors. He makes this argument, as I recall, in the context of not expensing stock options annually from financial statements. In my view, there is a tremendous amount of financial chicanery in this country because the auditors have become captive to their clients and this could produce the same lack of confidence in the US system as in Japan.

[carolinaman]

The Japanese trade balance has gone negative in the last 5 years. Previously they enjoyed a healthy positive trade balance. They are major exporters of autos, consumer electronics and computers. There is now strong competition from other countries and their auto companies now assemble cars in the US. This was not a factor in 1990 but might partially explain the difficulty of their economic recovery in recent years.

[CWhea1775]

I think Dutch had it right. Demographics are a key factor, and we are likely to see the same thing play out in many of the world's developed economies for the next several decades. The capitalist system is dependent upon growth, and growth is difficult to achieve when your population is shrinking, ageing, and people are spending down their assets instead of buying new ones. The massive real estate bubble may have precipitated the impact of this factor earlier, but I think this underlying issue is key.

[nisiprius]

My personal take.

Stuff happens. The search for certainty in past "long-term" statistics is a fool's errand, because this time is always different. The course of the markets and the economy is punctuated by seriously important policy decisions and changes in law. I've been reading Charles Geisst's "Wall Street: A History," and all I can say is that no sensible person can believe that the stock market was "the same thing" before and after the creation of the SEC. That was a sea change.

And for that matter, in a smaller way, so was the Investment Company Act of 1940, and the decision to treat stock dividends as pass-throughs instead of being corporate profits of the investment company. So was the change in the law in 1941 under which Treasury interest became taxable. So was the development by the Chicago Board of Trade of a market in options and futures on stocks, currency, Treasury bills, and so forth. So was the introduction of the 401(k). So was the ending of fixed brokerage commissions. So was the passage of Glass-Steagall. So was the repeal of Glass-Steagall. And on and on.

Unless you are confident that you're worked out a quantitative model of human policy decisions... what's the average duration of the typical Glass-Steagall act?... What's the size of the average World War?... you can't treat past statistics as anything more than the roughest ballpark numbers.

Here's the proof of this. According to Dimson & al., the average real return of the U.S. stock market from 1900-2015 inclusive, 116 years, has been 6.4%; for the rest of the world combined, 4.3%. The proof is not in the numbers. The proof is that as far as I know, nobody* believes these numbers are a reliable guide to planning for the future, because nobody believes the "global stock market" is the same thing today as it was in 1900.

As for Japan, things happen. Worse things happened to 2 of the 23 national markets studied by Dimson & al, they disappeared, went to zero.

By the way, a curious detail... if you actually look at the Dimson & al. chart (blue line), notice that "what happened in Japan" is barely visible. No, not there, that's the end of World War II. The 1989 crash and aftermath is barely noticeable compared to either the postwar crash or the 35-year postwar boom.

Average annual real return for the full 116-year period was 4.2%, almost the same as for the entire world ex-US.



*Maybe Warren Buffett? I don't know, because his sound-bite utterances never actually make his views clear. He's said "Indeed, who has ever benefited during the past 238 years by betting against America?" Very well, so much that plan I had for buying and holding the ProShares UltraShort S&P 500 fund for the next 238 years...

[RNJ]

Inquiring Bogleheads want to know:

I'm very fuzzy about why the Japanese market took a huge dive and stayed down for so many years. Can some of the pundits on this board explain it simply? The "Japan" situation is usually used as a rationale for maintaining a significant amount of international diversification, but I never have quite understood what caused that situation to occur. And of course, the second part of the question. Could a similar scenario happen in the US?

Re USA

Yes of course it could. A dramatic stock bubble and dot com crash in 2000-03 led to monetary measures and regulatory laxness which led to a housing bubble and collapse followed by the slowest post recession growth of any period since the 1930s. Policy mistakes compounded that, probably, due to particular political characteristics of the US system.

However the US has positive demographics (birth rate and immigration) and by the nature of its people and country is geared towards rapid change, writing down, writing off and moving forward. Consider the shale drilling boom, which is really (as a big effect) entirely post 2000-- there's rapid technology change for you in spades.

It's unlikely the US story would play out exactly in the way the Japanese one did. But stagnation is certainly possible.

These varibales are not independent of one another, and the latter could see a dramatic shift in the coming years.

[Engineer250]

History rarely repeats itself. At somepoint we will have some economic crisis but the cause is likely to be something different than the last one. Everyone seems to expect another national level real estate bust because that is what caused the last crisis or a sector meltdown like the dot.com bust (previous crisis). Personally I think we get something unrelated. But who the heck knows what that will be.

This is what I keep thinking. We are too programmed to remember the last crisis and think the next one will be the same. And yet...I live in a HCOL area and boy it's weird to see home values just screaming up, easily past 2006-2007 peaks. I know that's not the same in every housing market, but it's hard to see this as sustainable here when wages aren't going up the same. I had the same concerns in 2006, though I did not predict the crash. I just couldn't see how these home values could keep going up. So I don't know what the fix will be. Maybe local real estate bubbles will burst. Maybe we'll see crazy high inflation but a stagnation of home values that will temper it and even things out. No idea.

I also keep thinking of the "every x years there's a correction/recession". Could be every 4 or 6 or 7 or 8 years depending on what period you use. And plenty of people who think because our recovery has been so slow that it might be longer this time before another downturn. I don't know. I was invested (with a much smaller portfolio) in 2008 and can only hope I can weather the next thing. Luckily, this forum will be here with hopefully enough steady and cool heads.

[LadyGeek]

In reference to some earlier posts, please stay focused on investing. Economic policy and politics (of any country) are off-topic. See: Unacceptable Topics

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If readers can't do anything with the content of a topic other than argue about it, it does not belong here. Examples include:

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[Valuethinker]

I think Dutch had it right. Demographics are a key factor, and we are likely to see the same thing play out in many of the world's developed economies for the next several decades. The capitalist system is dependent upon growth, and growth is difficult to achieve when your population is shrinking, ageing, and people are spending down their assets instead of buying new ones. The massive real estate bubble may have precipitated the impact of this factor earlier, but I think this underlying issue is key.

You are certainly seeing that sort of sclerosis in Europe, although I believe to some extent that is self inflicted by the structure of the Eurozone.

However there are emerging markets. Whilst the Developed World + China are moving into their aging period, for India + other EM that won't come for several decades.

As most big cap companies are very international (and some small cap ones as well) that will be a significant factor. Look where the growth is for Unilever or P&G or Nestle, etc.

[wearahat]

Inquiring Bogleheads want to know:

I'm very fuzzy about why the Japanese market took a huge dive and stayed down for so many years. Can some of the pundits on this board explain it simply? The "Japan" situation is usually used as a rationale for maintaining a significant amount of international diversification, but I never have quite understood what caused that situation to occur. And of course, the second part of the question. Could a similar scenario happen in the US?

Some conjectures on factors:

1. Dive was big because the peak came not from fundamentals but credit and speculation.
2. Low population growth and population shrinking affects all the companies that rely on domestic revenue like staples, utilities and telcos.
3. Disinflation, low inflation, deflation and zero inflation affects the nominal returns of the market.
4. The largest sectors discretionary, industrials, financials and technology have had a hard time against all the international competition both emerging and developed.
5. Car manufacturers have faced competition from emerging countries where their primary market is and technology is playing a greater role.
6. Consumer electronics faced competition from emerging and developed countries.

Pharmaceuticals and technology is the most lucrative space. Japan doesn't have companies in this space nor do they have any energy or resource companies. Their dominant sectors are in a structural decline and are increasingly competitive.

Population decline results in larger inheritances and lower tax expenditures which offsets poor returns.
Deflation results in higher purchasing power which offsets poor returns.
Real income/assets per capita increases.

Look at GDP per capita ppp since 1990 and it has been increasing at the same rate as other developed countries.
They'll fund their retirement with high inheritance. Fewer children = more assets per child.

[sperry8]

Here's the proof of this. According to Dimson & al., the average real return of the U.S. stock market from 1900-2015 inclusive, 116 years, has been 6.4%; for the rest of the world combined, 4.3%. The proof is not in the numbers. The proof is that as far as I know, nobody* believes these numbers are a reliable guide to planning for the future, because nobody believes the "global stock market" is the same thing today as it was in 1900.

As for Japan, things happen. Worse things happened to 2 of the 23 national markets studied by Dimson & al, they disappeared, went to zero.

By the way, a curious detail... if you actually look at the Dimson & al. chart (blue line), notice that "what happened in Japan" is barely visible. No, not there, that's the end of World War II. The 1989 crash and aftermath is barely noticeable compared to either the postwar crash or the 35-year postwar boom.

Average annual real return for the full 116-year period was 4.2%, almost the same as for the entire world ex-US.

Great chart, really puts things in perspective.

[john4546]

Considering what happened in Japan, I do not understand how John Bogle can think that only investing in the U.S. stock market is appropriate. What happens if the same thing happens to U.S. stocks, but for different reasons? Eventhough foreign stock markets may be not as good or efficient as the U.S. stock market does not mean that they do not provide opportunities to U.S. investors. Just because these markets are not perfect does not mean that one cannot make money in them. The persistent multi-decade down stock market in Japan is what keeps me investing in foreign stock markets.

[Top99%]

I think one of the things that sets the bubble in Japan aside was the sheer magnitude and scope of it. It would be almost like if the tech bubble and the US real estate bubble (times some value greater than 10) had happened concurrently. It is just hard for me to see real estate getting *that* far our of whack in this country and as others have mentioned declining 99%. Certainly if the value of my home appreciated by an order of magnitude relative to inflation I would unload it and rent. So, I think the sheer size of the bubble + non-favorable demographics combined for a perfect storm unlikely to be repeated in this country at least.

[fatcharlie]

It kind of is happening right now in Europe and, to a lesser extent, the US. If there was a shock right now, there's not much room to move on interest rates to compensate.
However, it's also fairly likely that if there's a problem in the US, there will be a problem worldwide (see 2008), so it's not likely international diversification would be much of a help to Americans.

[SimpleGift]

One of the most significant things that happened in Japan was, due to their population aging, their working-age population (ages 15-64) started declining in about 1995 — and has been shrinking every year since (chart below). Soon to follow along this trend was the European Union in 2010, with China to follow in about 2018.

• 
  Source: The Economist

Fortunately, due to its slightly higher fertility rates and higher immigration rates, the U.S. is forecast to escape the fate of a shrinking workforce — even though its population is and will be aging right along with the rest.

[JBTX]

I have used the "what about Japan" argument in favor of international investing many times.

Can it happen here? That provides some context. Is it likely that something very similar will happen, with the same degree? Highly unlikely. Note: Highly unlikely does not mean "can't".

Is it reasonably plausible that the US could underperform world equities, due to some of the factors that Japan has experienced? Yes, that is very plausible.

Japan experienced both a real estate and stock market bubble and had nosebleed valuations. The value of real estate and stocks are very high here, certainly above historical averages. By any reasonable measure current US valuations are nothing like Japan's, but given recent trends, the run-up could continue, and a reversion to long term historical means would certainly be painful for investors.

Japan's problems were compounded with horrible demographics. An aging population, low birth rate, and very low immigration. it is hard to grow an economy, and thus your stock market, with those demographics. The US demographics are not nearly as bad, and better than most developed countries, but we are entering a phase of demographic challenges, lower ratio of worker to retiree, aging population, and seem to be starting a trend of relatively lower immigration (time will tell on that one).

As to the arguments by many intelligent and successful people that US is always better because of structural and regulatory superiority, my problem with that is:

1. It assumes that the international markets are inefficient and currently don't recognize that
2. It assumes that will always be the case.

A counter argument is that some international markets have more upside, in that they could get structurally/regulatorly (??)better, where US markets may very well be as good as it can get.

[Lauren Vignec]

Inquiring Bogleheads want to know:

I'm very fuzzy about why the Japanese market took a huge dive and stayed down for so many years. Can some of the pundits on this board explain it simply? The "Japan" situation is usually used as a rationale for maintaining a significant amount of international diversification, but I never have quite understood what caused that situation to occur. And of course, the second part of the question. Could a similar scenario happen in the US?

Hi El Greco,

I used to spend a lot of time thinking about this, because I distinctly remember in the nineties thinking, "Well the Japanese stock market just has to come roaring back now. It's been down so long!" Well, I was not exactly right, was I?

Right now a client of mine is looking at buying a hotel. She owned and managed one for decades, and finally sold because her brother wanted out of the business. But she is just not ready to retire. So I am helping her value hotels that she looks at. Valuation of small businesses is particularly difficult because there are so many idiosyncratic variables. But the fundamental issue is always the same.

Is the price too high?

Is the price too low, and will she get a great deal?

Or is the price just right?

Investing in stock markets is obviously not the same as trying to buy a hotel. But the fundamental issue really is the same. The issue is this: is the price too high? Too low? Or just right?

Diversification is great. In fact, diversification is necessary. But diversification is not magic. No matter how diversified you are, there is always the potential problem that the price is just too high. If everyone thinks the economy will be an 8 on a scale of 1 to 10, but instead it's a 6, stock returns may very well be atrocious. Even though a 6 is above average. If everyone thinks the economy will be a 2 on a scale of 1 to 10, but instead it's a 4, stock returns may very well be awesome.

So if you want to be very simplistic, you can just say that the Japanese stock market performed so poorly because the price was so high. Is it possible for the prices of US stocks to get that far out of whack? Absolutely. And all the things that anyone brings up--demographics, rule of law, past performance, etc., are just like all the idiosyncratic variables my client brings up as to why some hotel is a great hotel. Oh, the location, oh the company culture, oh this and that. Yes. That's why the price is so high.

Any market is capable of performing in a mathematically similar way to the Japanese stock market if expectations and prices rise to such a level that a subsequent crash leads to overly pessimistic expectations and a long period of low prices. The idiosyncratic reasons make for fun reading but do not provide a guide as to how likely crashes of a similar magnitude are in the future in some other market.

As for me, I diversify internationally. I will say, though, that I have less confidence than I used to that such international diversification is going to bail me out if a country as large as the US has Japan-style market performance over more than one decade. It's a nice thought. But I think that if we go down we're going to drag the whole world down with us. I think diversification is much more beneficial under the scenario that the US is just temporarily over-valued, while the rest of the world is fairly valued. And that possibility is certainly realistic enough to justify international diversification.

[CyclingDuo]

Inquiring Bogleheads want to know:

However the US has positive demographics (birth rate and immigration) and by the nature of its people and country is geared towards rapid change, writing down, writing off and moving forward. Consider the shale drilling boom, which is really (as a big effect) entirely post 2000-- there's rapid technology change for you in spades.

It's unlikely the US story would play out exactly in the way the Japanese one did. But stagnation is certainly possible.

These varibales are not independent of one another, and the latter could see a dramatic shift in the coming years.

Net-net our current run rate is around 39% of our annual US population growth being due to immigration (based on the chart and website linked below). No doubt, as you mention, if those numbers saw some sort of dramatic shift, there would be an impact. Even thinking about it, certainly points to diversity of international and emerging market investing if you look at the world population clock and the annualized 1.12% - 1.14% global growth rate: http://www.worldometers.info/world-population/

Our country has a history of limits being put on various segments of the population not being allowed to immigrate to the US at specific times, while other segments of the population were still allowed to immigrate.

We could speculate on any dramatic shifts or segments of the population in coming years being temporarily barred from immigrating, but it's too difficult to come up with any set of exact numbers that would be of any use at this juncture. If our current total immigration is totaling around 39% of our annual US population growth, it's hard to imagine that number dropping all the way down to say "less than 10%".



http://www.worldometers.info/world-popu ... opulation/

[Valuethinker]

Inquiring Bogleheads want to know:

However the US has positive demographics (birth rate and immigration) and by the nature of its people and country is geared towards rapid change, writing down, writing off and moving forward. Consider the shale drilling boom, which is really (as a big effect) entirely post 2000-- there's rapid technology change for you in spades.

It's unlikely the US story would play out exactly in the way the Japanese one did. But stagnation is certainly possible.

These varibales are not independent of one another, and the latter could see a dramatic shift in the coming years.

Net-net our current run rate is around 39% of our annual US population growth being due to immigration (based on the chart and website linked below).

Hi

The quoting got very out of whack on this thread.

Valuethinker did not write the underlined.

Valuethinker wrote the bolded.

There is correlation between immigration and birth rate. First generation Americans tend to have larger families (who are made up of 2nd generation Americans). The "fade" on this is quite fast, however, by the 3rd generation it's hard to see a distinction by birthrate.

What is true is that the USA is relatively Christian by world standards. And they tend to have larger families (I include Mormons in this). That's a major reason for the higher birthrate. There are other reasons.

[Valuethinker]

I think one of the things that sets the bubble in Japan aside was the sheer magnitude and scope of it. It would be almost like if the tech bubble and the US real estate bubble (times some value greater than 10) had happened concurrently. It is just hard for me to see real estate getting *that* far our of whack in this country and as others have mentioned declining 99%. Certainly if the value of my home appreciated by an order of magnitude relative to inflation I would unload it and rent. So, I think the sheer size of the bubble + non-favorable demographics combined for a perfect storm unlikely to be repeated in this country at least.

In dollar terms the US residential RE bubble was probably proximate size to the Japanese RE bubble?

However the US has a bigger GDP.

[SimpleGift]

Any market is capable of performing in a mathematically similar way to the Japanese stock market if expectations and prices rise to such a level that a subsequent crash leads to overly pessimistic expectations and a long period of low prices.

True. But inflated stock prices were only part of the story about what happened in Japan. From about 1975 to 1990, earnings-per-share of Japanese companies grew at an incredibly robust and steady pace (in green below). While investors subsequently got carried away, much of the price run-up (in blue) to about 1985 was justified by their excellent earnings growth.

• 
  NOTE: Negative earnings cannot be represented on log-scale graph.
  Source: MSCI Barra

After 1990, earnings growth collapsed for Japanese companies and didn't really recover for almost two decades. When folks worry about the U.S. stock market experiencing a Japan-like swoon lasting decades, this only seems possible if U.S. corporate earnings go through a similar prolonged collapse — which is possible, but perhaps not too likely, absent a catastrophe.

[grog]

I wonder if things are really all that dire in Japan in terms of quality of life.

[boglerdude]

Anyone have yen-denominated charts of US and Japanese markets

And an explanation of how to interpret them

[john4546]

OP,

I do not like to put all my eggs in one basket.

1) I invest in US total market index fund.

2) I invest in International index fund.

3) I invest in the total bond market index fund.

4) I invest in Wellington fund (world oldest mutual fund -> active managed)

5) I keep 1 year worth of emergency fund.

6) I bought a house with 30 years fixed mortgage as an inflation hedge.

7) I keep some amount of cash at home.

8) I have some amount of gold jewelry.

I cover all my bases. So, I do not worry and think about whether X can happen.

KlangFool

@Klangfool,

What is your international/domestic stock allocation? 50/50?

[KlangFool]

OP,

I do not like to put all my eggs in one basket.

1) I invest in US total market index fund.

2) I invest in International index fund.

3) I invest in the total bond market index fund.

4) I invest in Wellington fund (world oldest mutual fund -> active managed)

5) I keep 1 year worth of emergency fund.

6) I bought a house with 30 years fixed mortgage as an inflation hedge.

7) I keep some amount of cash at home.

8) I have some amount of gold jewelry.

I cover all my bases. So, I do not worry and think about whether X can happen.

KlangFool

@Klangfool,

What is your international/domestic stock allocation? 50/50?

john4546,

25/75 -> There is nothing scientific about this. My Wellington Fund is dominantly domestic. So, I could do much with my International stock index fund to bring the ratio up.

KlangFool

[dabblingeconomist]

This site provides a chart indicating that the CAPE in Japan was nearly 90 at the peak of the bubble.

By contrast, currently we're worried about overvaluation in the US when the CAPE is in the 30-35 range (and bond yields are far, far lower).

If the CAPE=90 figure is correct, is there any great mystery about what happened in Japan? At such an exorbitant level, there is essentially unbounded room for the market to fall, regardless of what happens to the economy. Indeed, to me this ex ante overvaluation seems much more important to the story than the subsequent economic underperformance in Japan (which is often exaggerated, since Japan did roughly keep pace in per capita terms with the rest of the developed world, and the underperformance in absolute terms is largely due to demographics).

On a similar note, this January 1990 New York Times article states that the dividend yield on an index of Japanese stocks was 0.47% at the time. This is arguably even more revealing than the CAPE figure, since earnings are just an accounting construct that varies from country to country; relative to share prices, the actual cash that Japanese companies were distributing to their shareholders was virtually nil. (Note that this figure is even worse than it looks relative to the current 1.5-2% US level, since companies in the US also distribute cash via buybacks. Also, as far as I know, currently there is no major developed-country market with a dividend yield below 1.5%.)

To me, the basic story of Japan is this: at the peak, it was a ludicrously overvalued stock market, far worse than the US in 2000 or (really) almost anything we've ever seen. You can easily avoid such a disaster by moving funds away from a country with such absurd asset prices. (International diversification is good too, but that's secondary to the basic "change your allocation when every valuation indicator is at historically and internationally unprecedented highs" message.)

[1nv35t]

During the 1970's/1980's Japan did exceptionally well



eating a lot into US global market share with great technological products (walkman's, motor cycles, cars, hi-fi's ...etc. etc.).

A number of large companies dominated their index, and then the overextended 1990 peak saw that bubble burst and much of the cake slice taken from the US returned (see how the grey region collapsed in the above chart).

Midcaps or anything other than the large cap index that was dominated by relatively few, that were still large even after their 'collapse' and investment rewards were more 'normal'

A large cap index has the problem of no top end exit. The largest stock remains in that index and the biggest can sometimes falter. A mid/small cap index has the added benefit of entry/exit in/out of the top/bottom and as such is less prone to extremes/concentration. I conjecture that the likes of small cap value 'outperformance' is a consequence of large cap drag (relative underperformance compared to a mid/small cap or more equal weighted combination of stocks). Japan 1990's was a good example of such large cap drag.

[lazyday]

You can easily avoid such a disaster by moving funds away from a country with such absurd asset prices.

Agreed. Around 1990ish, I owned international funds but refused to own any that had more than a few percent of assets in Japan. Around 2000, I owned 0% largecap US*. Today I have less than 20% of my equity in the US.

Today's US CAPE in the mid 30s isn't nearly as bad as Japan 1990, and the next 28 years probably won't be nearly as painful. But I believe there will be some suffering for those who insist on a 100% US allocation.

* Of course not all of my changes in response to valuations have worked out well.

[fennewaldaj]

I suppose if one wanted to automatically avoid excessive investment in overvalued countries the schwab fundamental indexes are a good option. They have at least the possibility of the opposite problem of over allocating to a value trap though I suppose.

[printer]

It depends what "it" is. If "it" is, "exactly the same thing that happened in Japan happens here" - that asking whether it can happen here is a good question. I think there's useful insight to be gained by looking into this, and I don't know the answers. But to me this question isn't the main question that one should ask. A central issue is the things you don't know. Like generals fighting the last war, it's possible to convince oneself that what happened in Japan can't happen in some particular other place, e.g., the US, or Germay, and that conclusion might even be correct, but, something else could happen. Taking that risk is part of what you get paid for.

[eye.surgeon]

I believe demographics is the reason it's continuing to happen in Japan

specifically an extremely low birth rate and no immigration.

[getrichslowly]

It would be nice if there was historical earnings data to go with the Nikkei 225 historical price data. Speculative price movements are noise. I suspect that any period of abysmal returns probably included a simple run-down in valuations.

It could absolutely happen here. Japan was simply the first country to face a shrinking labor force. Every country will eventually face the same trend as demographics mature.

[JBTX]

This site provides a chart indicating that the CAPE in Japan was nearly 90 at the peak of the bubble.

By contrast, currently we're worried about overvaluation in the US when the CAPE is in the 30-35 range (and bond yields are far, far lower).

If the CAPE=90 figure is correct, is there any great mystery about what happened in Japan? At such an exorbitant level, there is essentially unbounded room for the market to fall, regardless of what happens to the economy. Indeed, to me this ex ante overvaluation seems much more important to the story than the subsequent economic underperformance in Japan (which is often exaggerated, since Japan did roughly keep pace in per capita terms with the rest of the developed world, and the underperformance in absolute terms is largely due to demographics).

On a similar note, this January 1990 New York Times article states that the dividend yield on an index of Japanese stocks was 0.47% at the time. This is arguably even more revealing than the CAPE figure, since earnings are just an accounting construct that varies from country to country; relative to share prices, the actual cash that Japanese companies were distributing to their shareholders was virtually nil. (Note that this figure is even worse than it looks relative to the current 1.5-2% US level, since companies in the US also distribute cash via buybacks. Also, as far as I know, currently there is no major developed-country market with a dividend yield below 1.5%.)

To me, the basic story of Japan is this: at the peak, it was a ludicrously overvalued stock market, far worse than the US in 2000 or (really) almost anything we've ever seen. You can easily avoid such a disaster by moving funds away from a country with such absurd asset prices. (International diversification is good too, but that's secondary to the basic "change your allocation when every valuation indicator is at historically and internationally unprecedented highs" message.)

http://www.businessinsider.com/long-ter ... red-2013-8

Even if Japan cape 10 was only low mid 30s at the point of the crash, the 30 year return as represented by the Nikkei would have been approximately zero. Add about 1-2% points for dividends I guess.