A lesson from Japan – this bear market rally won't last much longer
By
Dominic Frisby Sep 23, 2009
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Tokyo: property prices collapsed
Shortly before New Year's Eve in 1989, Japan's Nikkei 225 stock market index hit a high of almost 39,000 points.
Tokyo - like London in 2007 - was the most expensive city on the planet. The Edo Imperial Palace was valued higher than the whole of the state of California. All the land in Japan - valued at $14 trillion - was worth four times the value of all the real estate in the United States. Choice property in Tokyo sold at $1 million (¥100 million) per square metre.
Then the bubble popped...
Japan shows what's possible in a bear market
A long, slow, grinding deflation followed. Twenty years later, prime 'A' property prices in Tokyo's financial district had collapsed, in some cases to less than 1% of their peak price; some residential homes were worth less than 10%.
That period – famously known as 'The Lost Decade' – should really now be re-named 'The Lost Two Decades'. A close friend of mine trades on the Japanese desk of a major bank. He describes Japan as 'a basket case' and is convinced we'll be looking at the lost three decades by 2019. I'm not so sure. There is a case to be made that Japan has made its final low.
But I don't want to go into that here. What I do want to look at is the magnitude and duration of the stock market rallies during that period.
There were at least six rallies that lasted six months or more, four lasting over a year. We had a 40% rally, a 50% rally, three around 60%, and even a 140% rally. Yet by late 2008, 19 years after the bubble burst, the Nikkei was below 7,000, some 80% off its high of 20 years earlier. Here it is in pictures:
Why am I interested in all this? Because it shows what is possible in a bear market. It's astonishing how long Japan's has gone on for and how low it has gone. But what's also astonishing is what fabulous rallies there were.
It's too late to buy this rally - but don't be short either
We are seeing something similar in today's markets. This rally has wrong-footed some of the smartest traders in town. It just keeps on going up. Every time you think it might finally turn back down, it rebounds. But the chart of the Nikkei shows that this is what bear market rallies do. In my view you'd be a fool to buy in now. But you'd also be a fool to short something where the momentum is so clearly to the upside.
I was at lunch yesterday with some investors and one insider explained his bank's position. The rally had surprised many of the fund managers and traders, and they were underexposed to it. They are reluctant to do a great deal of buying as valuations do not make sense, but they cannot afford to lose what little exposure they have, so they are not selling either. That is perhaps why this rally, like that in the property market, has been on such low volume and why there are so few sellers. But looking at that chart of the Nikkei, who's to say this rally can't go on for another six months?
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Of course, Japan had a much higher savings rate than we do here in the West. They had lower consumption levels, they ran a considerable trade surplus and they were able to export the inflationary consequences of their quantitative easing (via the yen carry trade, where people could borrow yen cheaply and use it to buy higher-yielding assets in other currencies, thus helping to fuel bubbles abroad).
But their bubble was driven by loose lending and mind-boggling asset price inflation. And so was ours. Post-bubble, the Japanese Central Bank was slow to react; ours were quicker. But Japan's reaction – to slash interest rates to zero, to issue currency and subsidise failing banks and businesses – has to all intents and purposes been the same as ours. There's every reason to expect the outcome and consequences to be similar.
In any case, surely it makes sense to take some profits you've made now. I don't want to give all this rally back. It's worth noting in the bigger picture that, even with the rally, stock markets are still some way off their all-time highs, oil is 50% off its all-time high, copper, real estate, silver, government bonds - virtually every asset you care to mention is trading some distance from its all-time highs.
Yet gold is retesting its high. It proves my theory. Gold will rise and fall with the overall market. But it will be the first asset class to rally after a fall, and its rallies will be of the greatest size, so that, over time, it significantly outperforms. I heard a nice maxim the other day from the US trader Larry Pesavento. He said, 'Buy gold and wait. Don't wait and buy gold'. $1,000 an ounce looks to be a line in the sand for now – you can imagine every mining chief executive has told his trader, 'Yep, you can sell ours at $1,000' – but once we're through, who knows where we go?
What real deflation looks like
By the way, if you want to see what real deflation looks like, have a look at the chart below. That shows how many ounces of gold it takes to buy the Nikkei. That's a big, big fall. It almost makes you want to sell your gold and buy the Nikkei, though that low needs to be retested first...
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