Learn from Japan and Have a Plan

As if we did not have enough negative news regarding the current housing debacle and the accompanying mortgage crisis, Goldman Sachs (GS) analysts came out with a report stating that 2 trillion dollars of loan reductions could be possible and could initiate an ensuing credit crunch. The implications are obvious: obtaining a loan would become more arduous which would put us closer to a Recession. Being dependent on almost $100 a barrel oil and foreign investment is only adding fuel to the fire. It is very interesting how just several short months ago the U.S. mortgage system was the envy of the world. Now unfortunately it seems the U.S. mortgage system is imploding.

In the early 1980's we were going through another financial crisis. Then, as now, times were becoming very difficult. However one major difference was the fact the government did not come in and bail out the financial institutions. They were allowed to fail. There was a proverbial wringing of excess. Possibly due to this wringing of excess we enjoyed one of the longest running bull markets. Mr. Bernanke and his colleagues have taken a different approach. They have lowered interest rates.

In life, as different as things seem to be, many times they are similar. What I am referring to is the case in the late 1980's when Japan's stock market was at a parabolic high. Japanese investors were buying up U.S. real estate assets as well as companies. Easy credit and cheap money were flowing like water [sounds familiar? see the situation in the U.S. up until recently].

In 1989 the Japanese stock market, which hit a high of approx 39,000, started to implode. The financial strength of Japan started to unravel. The Japanese government thought it was prudent to lower interest rates to bail out the lenders. In retrospect it is very clear that this did not work. For the last 15 years Japan has been experiencing virtually an economic disaster. The Japanese stock market has been down for now almost 18 years and sits at less than half of its former value at 15,154.61.

Zero rates did not lead to economic growth!

What I have learned from all my years of investing is that anything can happen and PRUDENCE is Paramount to Return. I have had this discussion regarding Japan with clients and not one thinks this can happen in America. After 1929 it took 25 years for the Dow to get back to its 1929 levels. Regardless of your beliefs and bias on the markets, have a plan. It is obvious when your investments and trades work, but more importantly when they do not work out, know when to exit according to your plan.

Comments

[Rich4REITs]

I Do agree with this aspect regarding Japan. However, I have no idea if US will follow the footprints like Japan or even worst. At least, Japan is one of the few countries with very less deficit..........

[Andy Abraham]

Let me say this.. I believe anything can happen..In the late 1980's Japan was also flowing with lax lending standards. The result is history. Even today in Japan many financials are having issues due to current lax consumer lending.

[BxCap]

Japan's GDP-to debt-ratio was better than the U.S. before 2000, but it is far worse than ours now. The first link will illustrate this shift, as Japan struggled and lost ground, resorting to currency sabotage to promote exports (as we are now doing).

This link will show 1995-2002
www.fin.gc.ca/ec2002/i...

This link is 2003
www.fin.gc.ca/ec2003/p...

This link has 2004 statistics
www.fin.gc.ca/ec2004/p...

I attempted to find the graph for the current ratios, but I'm having difficulty finding it. If your point was that we will see our debt-to-GDP rise, I do not agree with you, since GDP continues to climb and our debt is decreasing.

[WAKEUP]

This is one of the few articles that I have read which indicate an understanding by the writer of the full ramifications of the current financial situation. The U.S. is in for a tremendous repositioning of capital, and loss of a lot of same. There is a lot of "wishful thinking" type writing out there, all about how we have so many safeguards that weren't in place before the Great Depression, etc., but this crisis is of unbelievable proportions, and only the first few shock waves have hit, so far.

[Andy Abraham]

Even in this situation ...as in all situations...there are and will be oppurtunities. There are all different avenues to make money. There are always markets going up and those going down. The key is to have a thought out plan which encompasses many ideas such as money management, risk and correlations.

[droskoph]

Andy I have come to the same conclusion. Investor psychology is always the same, if there is no immediate reaction, it's baked into the recipe. For us, interest rate hikes from the BOJ are replaced by increasing energy costs. Oil still drags down GDP, although it may be less than the historical 1/2% for each $5 (above $45 per barrel). Paying for excess is something so distasteful in America that we defer it with more and more inflation. The plumeting dollar is reflecting the cost of printing our way out of recesssions instead of taking our medicine What good is a Federal Reserve that whitewashes excesses to appease the public while compromising our global status?

[David Lentz]

Exit? Exit to where?

Not real estate, not equities, certainly not debt or anything dollar-based.

Gold? The long-term track record of gold is erratic at best.

Suggestions, please. Informing us that we are in a quicksand and that we should have an exit plan is less than helpful. The quicksand and plight are pretty much obvious.

[Andy Abraham]

Sometimes short term tresuries are not so distasteful... Personally I have been purchasing them and avoiding like the plague ..cash equivalent funds with the SIV,CDO and CLOs spicings. A plan is something thought out some time ago... not in the moment with all the emotions..Yes as you mentioned the above ideas are not favorable at this time possibly.. but there are many markets to be involved in... there are always bull markets and bear markets. It all depends on your comfort levels and thoughts on investing. I personally have sold off virtually all my stock holdings as well as some of my Hedge Funds but actively pursuing investment ideas. Thank you in advance...

[ratsharp]

real estate .. in developing countries..which can be rented at fixed yields... so the price of the real estate..currency benefits can act as call options..

[Andy Abraham]

Maybe... but history has shown us that volatility exists in many developing countries.. ie..Russia 1998...eventhough it came back very strongly... thank you for your comments...

[BxCap]

First, the Federal Reserve and many other central banks DID step in to help.

www.fdic.gov/bank/hist...

Second, I enjoyed your post and agree that investors should be aware of what occurred in 1987, but they must also be aware that the emergence of India and China as commodity consumers changes the playing field that existed then versus now. I would have enjoyed your post more, if you would have shared your insights into this new dynamic, and how it will affect interest rates, global growth, credit availability, home prices/real estate values, commodity prices, stock sectors etc.

[Andy Abraham]

That is my point or should I say my opinion with a historical foot note. It seems the US is following in the foot steps of Japan as a pose to letting the market wring out the excesses. ...As far as China and the BRIC components they are experiencing high inflation as well as parabolic stock moves. In another of my articles I stated the BRICs might be vulnerable from a technical standpoint not withstanding the fundamentals. Take a look at my article... I am currently short one of the BRIC ETFs...No one knows where any market is going...there are fundamentalists and technicians... I rather look and try to be a contrarian and ask myself how much will this cost me if the trade does not work out. Any trade is 50/50 and as in Poker I am simply placing my bet.

capitalinvestor1836.bl.../

[Wise Owl]

Yes, we should have a plan. There is no disagreement there. I think, a plan of specifics by the Author would be welcome.

USA is not Japan where consensus building was most important and everybody sacrificed some instead of letting some implode.

It is the much hated Sarbaines Oxley Act that is casuing banks to mark their inventory to market, that is making a lot of companies guess or actually try to sell some inventory that is causing the large writedowns.

I think, banks and other financial companies like Master Card, Mortgage Lenders and others need to be required to have some capital requirements. We have heard a lot of issues with Fannie Mae for years.

So, our system allows a lot more of imploding than Japanese ever allowed. And, I donot see the problem like the 1929 and US is a lot more part of GLOBAL ECONOMY than Japan will ever be as it is still very closed, just like France and Russia are,as they donot like people from abroad owning their companies. No, such openness issue in USA.

So, plan needs to be in place. Identify which areas to avoid and where to take losses for each trade that is open on the books...

[Andy Abraham]

Thank you for your input...as far as a plan for specifics it totally depends on ones risk tolerances and beliefs. Personally I have a seller of much of my stock holdings and some Hedge Funds and in turn a purchaser of short term treasuries in my and wife's name.

I believe it is too early to be locating extreme value situations in stocks...and more downside is possible. I am focusing on another one of my tenents...that there are always Bull and Bear markets and always something is always trending. I am participating in these by moves by investing as a trader..Looking to buy strength and sell weakness... Looking at groups of commodities,currencies... 100 as well as the OEX100. This is a very basic concept that many Hedge Funds use. The difference is that I am not using leverage, I am using strict money management and correlation. It is the plan that I am using. thank you again for your input

[Peter Lynch]

Andy, you wrote:

"In 1989 the Japanese stock market, which hit a high of approx 39,000, started to implode. The financial strength of Japan started to unravel. The Japanese government thought it was prudent to lower interest rates to bail out the lenders. In retrospect it is very clear that this did not work."

There are many reasons why the Japanese economy has failed to recover from the 1989 bubble burst, but lowering rates too quickly is not one of them. The truth, in fact, is that the Japanese didn't lower their interest rate quick enough.

From wikipedia, en.wikipedia.org/wiki/...

"From the 1960s to the 1980s, overall real economic growth has been called a "miracle": a 10% average in the 1960s, a 5% average in the 1970s and a 4% average in the 1980s.[10] Growth slowed markedly in the 1990s, largely due to the Bank of Japan's failure to cut interest rates quickly enough to counter after-effects of over-investment during the late 1980s. Because the Bank of Japan failed to cut rates quickly enough, Japan entered a liquidity trap."

Greenspan has used Japan as a case study for his aggressive rate cuts in the aftermath of the 2000 internet bubble. In hindsight, he may had been too aggressive.

I have no idea where this market is going, and I gave up picking the bottom long ago. But like the tech bubble in 2000-2002, there are a lot of bargains out there. Investors just need to know where to find them and have the conviction and patience to hold.

good luck

[Peter Lynch]

Andy, you wrote:

"In 1989 the Japanese stock market, which hit a high of approx 39,000, started to implode. The financial strength of Japan started to unravel. The Japanese government thought it was prudent to lower interest rates to bail out the lenders. In retrospect it is very clear that this did not work."

There are many reasons why the Japanese economy has failed to recover from the 1989 bubble burst, but lowering rates too quickly is not one of them. The truth, in fact, is that the Japanese didn't lower their interest rate quick enough.

From wikipedia, en.wikipedia.org/wiki/...

"From the 1960s to the 1980s, overall real economic growth has been called a "miracle": a 10% average in the 1960s, a 5% average in the 1970s and a 4% average in the 1980s.[10] Growth slowed markedly in the 1990s, largely due to the Bank of Japan's failure to cut interest rates quickly enough to counter after-effects of over-investment during the late 1980s. Because the Bank of Japan failed to cut rates quickly enough, Japan entered a liquidity trap."

Greenspan has used Japan as a case study for his aggressive rate cuts in the aftermath of the 2000 internet bubble. In hindsight, he may had been too aggressive.

I have no idea where this market is going, and I gave up picking the bottom long ago. But like the tech bubble in 2000-2002, there are a lot of bargains out there. Investors just need to know where to find them and have the conviction and patience to hold.

good luck