Lost Decade

The mother of all bubbles is here

Of late, there’s a chart making the rounds, causing worry among investors. On the left, we have the Nikkei, the Japanese stock market index, which peaked at an all-time high of epic proportions before it came toppling down in one of the longest slumps that an economy has been in. In fact, whenever talks of a “lost decade” arise, Japan is the textbook example that’s brought up. On the right side of the chart, we have the Dow Jones… And it looks worryingly similar to the Nikkei before its crash.

Source: WallStreetBets

So in this week’s deep-dive let’s break down the reasons behind Japan’s Lost Decade, investigate whether we are at risk of going the same way - And most importantly, find out how you can use this opportunity to make some money.

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What happened in Japan?

Japan is an extremely hard-working country. In the 70s and 80s, Japan’s economy witnessed a resurgence after the war. America unpegged the dollar from the Gold Standard - while this move gave the US increased control in the global oil market, it also opened up trade opportunities for other countries. Countries that relied heavily on exports for their economies, like Japan and Germany, benefitted by building up a trade surplus against the US and growing during this time.

Land and stock prices during the bubble | Source: NBER

But this economic growth also began an asset bubble in Japan. Real estate and equity prices began to rise because of low-interest rates leading to a disconnect between the prices and the underlying value, and at a crucial period where this rise could have been controlled, the Government decided to wait because the Black Monday crash had just happened in America and there was uncertainty all around. In hindsight, this delay was a huge mistake. When the bubble popped, it was a disaster.

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The rise and fall

The bubble is remembered as a sad warning against irrational exuberance - but it’s easy to forget how high the bubble went before it popped! Here are some statistics:

1. From 1956 to 1986, land prices increased 5000% - even though consumer prices only doubled during that period.

2. Share prices increased 3x faster than corporate profits. The Nikkei went from $10,000 to nearly $40,000 in just four years.

3. The total Japanese property market was valued at over 2,000 trillion yen. The total value of Japan’s land - which is about the size of California - was worth 4.1 times more than the United States’ land. Considering that the USA is 25 times bigger than Japan, this makes the land 100x more expensive!

This absurd increase in prices was definitely being noticed, but everybody wanted to stay on board as the stock market train rode to the top, adding fuel to the fire. When the government finally stepped in by increasing interest rates, this led to the beginning of a crash that lasted for a decade before it bottomed. The Japanese stock market is now trading lower than where it was 30 years ago.

Nikkei stock price 1988 to 2022 | Source: Macrotrends

If you think something like this is impossible when it comes to the US stock market - think again. In 1954, the SP500 was the same price as it was at the peak of 1929. The stock market was also HIGHER in 1968 than it was in 1978, and, if you had invested in 1999, it would have taken you over 10 years for prices to reach the same level after the dot-com crash. 

S&P 500 from 1999 to 2016 | Source: Macrotrends

So, as you can see, a “lost decade” isn’t ENTIRELY out of the ordinary, it’s not like it hasn’t ever happened before, so…

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Where are we now?

In some ways, what is happening in the United States now is suspiciously similar to what happened with the Nikkei.

1. When the pandemic threatened to put a sudden stop to economic activity, interest rates were slashed to record lows to stimulate the economy.

2. This led to high speculation leading to a rapid increase in asset prices. In fact, two of the largest recorded daily increases were during 2020. The Nasdaq nearly tripled in price, and home affordability plummeted.

3. When the Fed saw inflation rising in tandem, they announced their plan to increase interest rates and reduce their balance sheet, which led to…

4. Falling prices. The S&P500 fell by nearly 20%, the Nasdaq is more than 30% down from its all-time high, and asking prices for homes have begun to drop.

To make matters worse, we have experts chipping in to say that we might be witnessing the burst of a bubble. Ray Dalio of Bridgewater, one of the first to warn of the possibility of a “lost decade” stated that consumer demand would slow leading to less corporate profits, and some companies won’t make it through. The Vice Chairman of BlackStone Capital Management said that stocks are overvalued and as cheap debt becomes difficult to obtain, profits would fade and stock prices would fall.

And finally, one of the investors I respect the most, Charlie Munger, said that stocks and bonds are in a bubble - The Federal reserve’s decision to artificially keep interest rates low, combined with an excessive amount of money printing and an irrational enthusiasm for investing drove up stock prices to unsustainable levels and the stock market might see lower than average growth over the next decade as a reason.

Even Michael Burry has warned that rampant speculation has driven the market to the brink of collapse. Does all this mean we are heading the way of Japan?

Source: Tenor

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US vs Japan

Though there is some similarity in the way things are unfolding, there are some key differences between the US and Japanese economies.

First, let’s look at the workforce. The Japanese workforce has been continuously shrinking because of an aging population. Lesser and lesser people are having children. Combined with this is the fact that Japan is extremely strict with immigration policies - The US has a 17.4% foreign workforce compared to Japan’s 1.5%! The Japanese economy has remained relatively flat due to these reasons.

Second, Japan is the fourth largest export economy in the world - But they are also heavily reliant on oil imports. Any disturbance in this supply which is outside their control can leave them in a precarious position.

Third, Japan has a lot of zombie companies - companies that are kept alive by the government for the sole purpose of allowing people to work. While this is a global problem, zombie companies aren’t much of a concern in the US.

Finally, the very nature of the Japanese economy is different in a fundamental way. Whereas we are heavily credit-based, Japan holds a LOT of cash. 52% of the average household’s assets are held in cash. This makes sense considering the decades of negative inflation that they have experienced, but the security they get is traded off for slow growth which isn’t the case in the US.

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How to make money in a lost decade

So here’s the deal. You would have lost money if you had invested during a lost decade (duh), but this is only in the worst-case scenario in which you invest only once at the beginning of the crash and then stop investing. A crash is never a direct descent to the bottom - there are ups and downs throughout, and if you had stuck to your plan of investing consistently, you would still have made a profit!

Consider the period from 2000 to 2012. If you had invested just once in the beginning, you would have made a total of 4.66% and a total of 32% if you had reinvested the dividends. But if you had invested consistently month on month, you would have bought into more of the lows, as shown below:

Buying the lost decade | Source: Novel Investor

Your net returns would have been 24% without dividends and 42% with dividends! Sure, an average return of 3.5% isn’t amazing, but hey, during a lost decade, it’s not bad either.

That’s why, even if we do see a lost decade, it’s only going to be lost for people who stop investing in the markets. Anyone who continually buys in through the highs and lows will have an opportunity to increase their returns, just by sticking to the same strategy. 

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In terms of my thoughts, I agree with Charlie Munger in that we should stop getting used to the huge returns we have been seeing in the recent past and prepare for a lower than average return over the next 10 years. Hope for the best, and prepare for the worst!

A lost decade is bound to happen at least once or twice in a lifetime, but our economy is fundamentally different compared to that of Japan, and we’ve survived every other lost decade and continued to grow. But what do I know, I’m just another YouTuber.

See you next week with another deep-dive!

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