Even If We Follow Japan's Path, Stocks Are Not a Sell Right Now

I’m one of the newest members of the ‘we are the next Japan’ community. The similarities are just too striking. A real estate bubble, followed by a financial crisis with no clear solution. Wasteful government spending, ballooning the countries' debt/GDP ratio (Japan is at 170%, we’re projected to be at least 120% and our ’stimulus’ plans have just started). We share the highest corporate tax rates in the developed world. Midway through this mess, both countries raise taxes. Japan raised a consumption tax, and the Democrats are projected to let the Bush tax cuts expire for those making $250k or more (if any of those people are left).

My Democrat friends will quickly point out that Japan raised a consumption tax, whereas we will just raise income taxes on rich people (who just burn their money lighting their Cuban cigars while making an evil laugh). After all, it’s not like people making $250k or more would ever actually spend their money or put it towards expanding their own businesses (since that group is disproportianatly composed of successful small business owners).

There are some other differences as well. Japan’s asset bubble was seemingly worse in terms of overvaluation of assets, though at least their people had actual savings. Japan’s preferential method of wasting money was building bridges to nowhere, whereas we prefer to spend $10 million so some middle school can have a state-of-the-art drill team.

Even if we are the next Japan, though, that does not necessarily mean stocks are a sell. Let’s look at how the Nikkei did. The Nikkei’s peak was about 38,915 in 1989. In 1990, it dropped to 23,848, a loss of 38.7%. The S&P 500 dropped 38.5% last year.

In 1991, the Nikkei closed just shy of 23,000, recording a small loss on the year. It ranged though from 21,456 to just over 27,000. Given the S&P 500 is already 50% off of its highs, it means our low is lower than their low in the second year of their great bear market, and we have a lot of temporary upside to go.

The Nikkei then cratered again in 1992, ending the year around 17000, a loss of about 26%. From 93-99, their market seesawed. It then boomed with the tech bubble and has now bust along with ours, with the Nikkei just above 7400 Friday.

This is a crude comparison, but it serves as a reminder that even if a decade of economic malaise is ahead of us, stocks aren’t necessarily a sell right now. If we’re on the same path as Japan, stocks are due for a short bull run before collapsing again. As bearish as I may be about the US economic future, I won’t bring myself to short stocks right now.

But if we hit S&P 950 again, it’s time to sell, sell, sell.

Disclosures: Long stocks….for now.

Comments

[kelm:]

Yes, I agree broadly with your analysis. What is actually rather odd about the current market is that we haven't had a big run up since the fall last year. Once we get some clarity on the banks there is probably a good chance. Having said that, our equity markets are fundamentally impaired due to the financial crisis and indebtedness. You may be able to play the indices for a counter-trend bounce but it is very risky. Even shorting at this point is risky as the market keeps getting whipsawed by news leaks and rumors.

Better to develop a fundamental thesis involving the major forces at work in the world economy and play those.

Feb 23 09:33 AM

[ACCOUNTANT:]

one of the fallacies of your analysis is that, when the Nikki peaked at 39000, it was at absolute historical peak levels in terms of its relationship to Japans GDP or price earnings ratio. When the S & P 500 peaked in 2007, it's relationship to the UD GDP was only about 15% over the average of the past 60 years, and the trailing price earnings ratio was only about 7% higher than the historical norms. In other words - it was really not in a bubble phase in the first place and now it is down 50%.

So i agree with half of what you say - stocks are not a sell at this point but disagree with the other half - that being that if it hits 950, its going to take another long dive.

Feb 23 09:39 AM

[Fred Voetsch:]

"There are some other differences as well."

Yes, Japan had America on a buying binge that could never end (whoops!) to prop up their economy and so their secular bear market had a lot of support. Who will prop up the largest economy in the world.

You make the mistake of looking at another era and directly apply number to now; BIG MISTAKE!

You need to find patterns, causes, etc from other eras and apply them to our CURENT CONDITIONS.

Current Conditions:

1. Overpriced stock market based on historic valuations. Ok, we're getting close to "fair value".

2. Overpriced market based on trailing earnings and earnings that are accelerating downward.

3. A weak global economy that has underperformed all expectations for over a year and continues to do so.

4. A housing market that is accelerating downward.

5. A consumer that has retrenched and is need of rebuilding nonexistent savings and reducing debt.

6. Fear of conditions never seen by most people in their lifetimes.

7. Terrible demographics as baby boomers move from their peak earning years to sucking wealth from the economy.

I could go on but let me summarize by saying the Dow will hit 5,000 in 2009 and will likely bottom out somewhere around 3,000 in 2010 or 2011 and may get and stay lower depending on how bad the government screws things up.

Feb 23 12:36 PM

[CJJ:]

All these "smart" people and no one gets it. The fire is already burning. You don't fight the fire with more fire and you don't just wait until the fire burns out hoping that happens before you get burned.
The metaphor works but if everyone is burned in the fire, doesn't matter if you were the cause of the fire or not. You're toast either way.

So what do you do? You put out the fire. Whatever you want to call it you cancel the debt. Sure the US will be a big debt eraser in real $ figures...but you forgive debt of Japan, you forgive debt of S. America, C. America, Africa, etc. Everyone. You learn the lessons without cutting off your legs because you had a small cut on your ankle.

There is no reason to pay for some 10,20,30 years of mistakes. No one wins without saying goodbye to the debt.

There is no accountability framework set up now so moral hazard is a moot point. Start over with accountability in place. Economic crime should be on par with physical crime.

Feb 23 02:03 PM

[Loucleve:]

Hmmmm. Personally, I dont think I am in the market for financial advice from "Bluto".

Hey, a little humor, huh!

Feb 23 09:51 PM

[ozcutty2:]

The whole Nikkei in 1989 was like the tech boom. Not connected with reality. The 1997 Dow high was no where near as crazy. I'd say most shoes have dropped in this downturn. Mid 2009 i expect a rally based on an assumption of a 2010 recovery.
The question is buy now or wait another couple of months hoping the index will drop a bit more

Feb 23 11:03 PM