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moneysense.ca, 25/02/09
The lesson from Japanese Stocks
Current issue:
Any discussion on long-term stock returns inevitably turns to the unfortunate experience of Japanese investors who saw the Nikkei 225 tumble from the 38,915 it closed in 1989 to its current level of just above 7,500 nearly twenty years later. Stated in these stark terms without any context, the Japanese example appears to question the validity of buying-and-holding equities for the long run but appearances are deceptive.
Japanese stocks increased 100-fold from 1955 to 1990. Between 1986 and 1989, the Nikkei 225, a price-weighted average of stocks trading on the Tokyo Stock Exchange, tripled in value and stocks traded at unheard of valuations: 60 times earnings, almost 5 times book value and more than 200 times dividends. Nippon Telephone and Telegraph (NTT) traded at a P/E of over 300. The collapse from these dizzying valuation levels was shift and brutal — the Nikkei lost 38.7%, 3.6% and 26.3% over the subsequent years for a total loss of over 56% in three short years.
And as is common in bubbles, the “this time is different” arguments were common. Jeremy Siegel, relates the following anecdote in Stocks for the Long Run:
During his travels to Japan in 1987, Leo Melamed, president of the Chicago Mercantile Exchange, asked his hosts how such remarkably high valuations could be warranted. “You don’t understand,” they responded. “We’ve moved to an entirely new way of valuing stocks here in Japan.” And that is when Melamed knew Japanese stocks were doomed, for it is when investors cast aside the lessons of history that those lessons come back to haunt them.
The lesson to be drawn from Japanese stocks then is that valuations matter a great deal. Stocks cannot be expected to provide satisfactory returns if investors pay too high a price. It was true of Japanese stocks in the late 1980s, US stocks in general and tech stocks in particular in the late 1990s and will hold true in the future.
moneysense.ca, 25/02/09
Yes, it all depends upon valuation. But how do you value a stock or income trust unit? An oil company at $130 / barrel oil has more value than the same oil company at $70 / barrel oil. A REIT when property is leasing at $15 / sq ft is worth more than the same REIT when they can only get $8 / sq ft. A retailer selling $10B dollars of merchandise makes more money than when its overall sales drop to $1B dollars. The dropping stock prices reflect plummeting asset values and cash flow figures. Does this mean that everything is on sale right now? People who would say yes probably think that stocks are living breathing creatures that remember their 52-week high value and snap back there like a rubber band.
The buy and hold thesis only looks good under special circumstances. One must carefully time the market to make BH look attractive.
The Japan index appears to be heading for a break below it’s Nov. low like all N.A. indexes.
So what about the record of the index since then? That’s usually where the argument against buy-and-hold starts…post crash. The argument against buy-and-hold wrt the Nikkei is that it hasn’t gone up SINCE the crash.
I’d like to see what happens when an efficient market advocate tries to explain the peak of the Japanese market
It might have changed to a new way of valuing stocks, but who would buy them when there’s other investments available to pay you back in less than a century?
Phil: income affects value, but a temporary drop in income is normal. Except for a few businesses that were built on completely unrealistic expectations it’s possible for the long-term results to continue as usual. Not every stock is on sale but it’s more than likely that good ones were affected almost as much as bad ones.
I had some data on japanese stocks going back to 1914, which basically showed that between 1919 and 1949 Japanese stocks were pretty much stuck in a range. Maybe the reason why Japanese stocks don’t perform is …cultural?
However the fact that the asset prices were so high definitely is a hindrance to long-term performance.. The Imperial palace in Tokyo in 1989 costed much more than the whole state of california..
Phil: It is true that estimating future earning isn’t a hard science and I’ll admit that based on trailing earnings, I thought stocks were reasonably valued in 2007 to deliver modest returns that were still better than bonds. But it is clear that even based on trailing earnings, stocks were clearly overvalued in 2000. S&P trailing P/E was greater than 33 in 1999, Nasdaq traded at more than 100. I still recall that valuations of big-cap tech stocks were considered “reasonable” when the price-to-sales ratio was 10!
Canadian Money: I have no idea how carefully timing the markets qualifies as a buy-and-hold strategy.
rm: I don’t have total return data or inflation data for the Nikkei. So you’ll have to take the following with a large dose of salt. Assume you invested 1000 yen every year since 1993. You’ll have a grand total of 990 yen in *profit* at the end of 2008. i.e. Total investments made: 16,000. Value of portfolio 16,990. Other starting years and the profits/losses are as follows:
1994: 1085
1995: 1207
1996: 1430
1997: 1660
1998: 1869
That sounds great but keep in mind that investors who started out earlier aren’t very happy with the results:
1985: -782
1986: -1108
1987: -1278
1988: -1091
SP: Markets are usually efficient but it is clear that they are not always efficient. As Warren Buffet says this makes all the difference. I have no problems accepting that.
Dividend Growth Investor: I read yesterday that Japanese stocks lost 96% in value in the decade following 1939 due to the Second World War. From 1900 to 2008 Japanese stocks returned a real 3.8% but with much higher volatility. I don’t think that is shabby at all. I also draw the conclusion that the Japanese experience teaches us to diversify globally.
CC: Jeremy Grantham says Japanese stocks are very undervalued at this point after a 20 year bear market. Japanese companies have some of the healthiest balance sheet and Jeremy Grantham says Japanese companies can be considered blue chip companies at this point.
Overweight Japanese market seems like a good idea.
Yes, that’s exactly my point. But the point of your article seems to miss the lesson from Japanese stocks…and that’s that simple buy-and-hold of even a cheap index fund risks the Japanese Nikkei results of basically flat returns for decades.
My point is that the stock market doesn’t remember what price that you (or anybody else, for that matter) bought a stock at, so there is no guarantee that it will ever go back to that price. Just ask anybody who still holds Nortel stocks today.
A stock which has fallen 80% to the price where it is today has just as much chance to go 5x in price back to its peak value as a stock of a new company trying to make it in the world. But human nature THINKS that the stock which fell will get back to where it was, whereas we THINK that a new stock will never get anywhere.
[...] Canadian Capitalist looks at the lessons that can be learned from the Japanese stock market. [...]
rm: Obviously, I wasn’t very clear on the point I’m making. It is that when valuations are too “high”, future stock returns can be expected to be modest. But what I find astonishing is that despite a fall from 40,000 to 8,000, Japanese investors putting money regularly to work were slightly positive to slightly negative. Granted that isn’t much to write home about for investing over 20 years but it is a markedly different outcome than saying Japanese stock lost 80% of value over 20 years.
But keep in mind that this is investing in Japanese stocks and nothing else. Now, I believe investors need to diversify by holding other asset classes such as bonds, a bit of cash, REITs and also diversify stocks globally. They also need to keep expenses low, not chase performance and rebalance their portfolios occasionally. Doing all these little things right puts the odds markedly in favour of the investor.
You have to be careful when making comparisons between the equity markets of different countries as the socioeconomic factors do not often translate well.
A few things you have to consider about the Japanese market.
Given the lack of transparency there was it possible for large brokerage houses to rig the markets in conjunction with their large customers? If the bubble was manufactured for the benefit of Nomura etc… and their customers, then its a transfer of wealth from the middle/lower classes to the rich. In that context a bubble makes sense. Sound familiar?
Japan during this time was restructuring their welfare society. Companies in Japan previously had little concern for their shareholders and stock price as their primary responsibility was to support their workers and their towns.
A secondary company function was to support other related companies by holding their shares and supporting their share prices. As a result the valuations were completly off by any western standard.
There are many other differences as well. Did you know that dividends are still often paid with product? If you invest in MacDonalds, for example, you might get burger coupons on a quarterly basis and so forth.
You have to be quite careful when you are considering investing overseas.
[...] Canadian Capitalist tells us a lesson from the Japanese Stocks. [...]
West Coast FP: Your last point reminds me about a box of snacks. Long time ago, my grandpa used to bring one or two boxes of cookies, snacks, and sweets from shareholder meetings of a confectionery company. He explained to me that the box was “company’s gift to shareholders. ” 10 years later I learned that I had some shares in that company through him. Back then, I didn’t know stocks, dividend and shareholder, but that boxes of snacks were the best dividend payments for 9 year old kid!
I posted a link to a great article on the lessons learned during Japan’s banking, real estate, credit deflation…
http://www.planbeconomics.com/2009/02/11/lessons-from-japan/?preview=true&preview_id=570&preview_nonce=49d2e18552