Japan has seen plenty of false dawns – but this time it’s for real

Japan suffered one of the most spectacular bubbles in financial history. But today, the market is so cheap that it’s practically the opposite of where it was in 1989. Merryn Somerset Webb explains how to profit.
On 2 February, 1987, Newsweek’s cover offered unwelcome news to Americans: “Your next boss may be Japanese”. This seemed likely at the time: Japan’s GDP made up 18% of global GDP; five of the world’s ten largest commercial banks were Japanese; and pretty much every big commercial property development in the world had a Japanese name on it. As all great bubbles do, Japan’s had started out sane. In the post-war period, Japan had very low levels of debt and infrastructure – and was strongly encouraged by the US to go for export growth (America was keen to see Japan proving the superiority of capitalism). Lending kicked off and fast translated into industrial-powerhouse-style GDP growth. Confidence grew. Over-ambition arrived.
Then came the Plaza Accord in 1985 – when the US, beginning to feel that it might have created a monster, urged Japan to strengthen the yen (to make its products less competitive with home-grown US ones). The yen rose 50%. Lending to exporters became less profitable. So Japan’s banks stepped up small company and property lending – and everyone began to use the stronger yen to buy abroad. The explosion in private lending was epic. From 1985 to 1990 the value of commercial real estate loans more than doubled. The average size of a domestic mortgage doubled. Non-mortgage household debt near-tripled. Building after building “that would not be sold or even filled for years or even decades” went up, says Richard Vague in his A Brief History of Doom. Abroad the boom was shocking: in 1989, Mitsubishi bought the Rockefeller Centre, Sony bought Columbia Pictures and Japanese banks accounted for 20% of all property loans in California. And of course, the stockmarket, buoyed by extreme leverage and extreme optimism, went berserk.

At its 1989 peak, with the Nikkei nearing 40,000 (38,916) and most commentators expecting 45,000 by the year end, the average price/earnings (p/e) ratio was up to nearly 70 (four times the US average) and the dividend yield was down to a mere 0.5%. The Japanese stockmarket made up 45% of the MSCI World Index. The land on which Tokyo’s Imperial Palace sits was said to be worth more than all of California. This might not have been entirely true – but the fact that it was widely considered plausible tells you all you need to know about just how much of a bubble this one was.
The end of the bubble era
Then, with debt growing faster than GDP and land valuations insane, came the inevitable crash. In 1990 the Nikkei fell 38%. By 1991 it was below 25,000. By this point, land prices were falling fast too – and the more they fell, the more the loans they backed went bad. Over the next 20 years (a good few of which spanned my own rather disappointing career as a Japanese equity broker), it just kept falling, eventually bottoming at 7,055 in 2009, by which point the crisis was thought to have cost the equivalent of 20% of Japan’s GDP and the attempt to sort it out had taken the public debt-to-GDP ratio to 230% (double that of the US). Today, with Japan’s GDP making up just over 4% of global GDP, the Nikkei is back to 21,700 (the market now makes up 8% of the MSCI World Index). Better than 7,000 – and up nearly 20% in the year to date – but still a long way off that 1989 peak.
So what next? Almost everyone now hates the Japanese market. Analysts have deserted it in droves; fund managers endlessly complain that no research is ever done on the stocks they hold (it mostly isn’t); and 2018 saw the highest level of foreign selling in 30 years. Most private investors have fallen for Japan at some point (me more often than most) and all have been disappointed: one of the few things the Japanese stockmarket has excelled at since 1990 is false dawns.
The two most recent? Things looked good in 2005 when the telegenic Junichiro Koizumi, then-prime minister, looked as though he really would upend Japanese politics with his “no growth without structural reform” policy: postal privatisation triggered a 40% surge in the Nikkei to around 17,000, before it fell back to 8,000. Then there was a good one in late 2012, when Prime Minister Shinzo Abe kicked off his economic reforms and Bank of Japan governor Haruhiko Kuroda humoured him with a vast quantitative easing programme. The Nikkei rose 57% in a year. We told you to buy. That was perfectly good advice. The market is up 30% since. But it hasn’t gained traction with international investors: Japan remains the most under-owned developed market in the world.
This is no false dawn
Still, we are going to tell you to buy again. The first reason for this is economic. Japan has its problems – in spades. It has an ageing and declining population (without immigration, the two go hand in hand) which often makes nominal GDP growth look worse than GDP growth per head. It has dragged itself out of its deflationary quicksand, but is nowhere near achieving its 2% inflation target despite a terrifying level of national debt that will surely one day lead to a nasty bout of inflation. With interest rates at zero and deflation still an occasional threat you probably don’t need to worry about inflation in the immediate term. But keep an eye on it – the seeds of each crisis are always sown by the reaction to the last one.

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