As concerns of a double-dip recession have increased, many commentators are suggesting that Japan’s post bubble economy and stock market will serve as a road map for what the U.S. can expect.
The obvious implications are that we will suffer from deflation, low-growth, and a secular bear market in stocks for many years (if not decades) to come. I believe this comparison is flawed.
The U.S. will not follow Japan’s trajectory and high-quality U.S. stocks offer great risk adjusted returns right now. Here are three reasons why.
1) Magnitude: In 1989 Japan had massive twin bubbles — both real estate and equity. The Japanese stock market was in the stratosphere with an earnings multiple well north of 100.
Japan’s real estate bubble was so ludicrous that the Imperial Palace in central Tokyo (only about 5 miles in circumference) was deemed to have the same value as the entire state of California. Now that is a bubble!
The 2007 property bubble in the U.S., by comparison, was residential-focused and less dramatic. While it is true that aspects of this bubble had ripple effects into other markets (commercial real estate, credit markets and equities), the magnitude of overpricing was nothing like Japan of 1989.
US equities in 2007 were only modestly over-valued at roughly 17 times trailing earnings. Were those earnings overstated? Certainly. But the point here is to show that on a relative basis the excesses were nowhere near as extreme of Japan in 1989.
2) Demographics: Japan’s demographics are abysmal when compared to the U.S. As a primarily mono-cultural society, Japan cannot easily use the immigration lever to counteract the natural graying of a wealthy society.
The U.S., on the other hand, has a lower average age, a higher birth rate and a history of embracing immigration. All these factors should keep U.S. demographics from having the same deflationary impact as Japan’s did.
3) Monetary Policy: Japan suffered from severe policy error. The Bank of Japan (BOJ), understandably, did not appreciate the magnitude of the economic and financial problems it faced as the twin bubbles burst.
Monetary policy was clearly not aggressive enough. The BOJ was too slow to cut rates initially; too timid with quantitative easing (QE); and even raised rates at inopportune times in the nineties. These errors were compounded by a lack of restructuring of the banking system.
“Zombie” banks were allowed to hold incorrectly priced assets for many years without restructuring. The Federal Reserve has learned from Japan’s mistakes and been much more aggressive on both fronts.
Bernanke, as a student of the Great Depression, has made it clear that he will respond aggressively to the specter of deflation. He earned the moniker “Helicopter Ben” from a speech urging the BOJ to be more aggressive with its monetary policy.
Starting in Q1 2008 the Fed has indeed been aggressive — initially through rate cuts cut and later with elements of QE. U.S. bank regulators have also been far more effective (than Japanese regulators were) in forcing problem banks to mark down assets and raise capital or be taken over.
Clearly the U.S. does face significant economic challenges and the nascent recovery will almost certainly continue to be slower and more uneven than normal; but for the reasons above, the odds of Japan-like lost decade (or two) are very low. It is worth remembering J.P. Morgan’s famous quote, “…that any man who is a bear on the future of this country will go broke.”
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John B. Helmers is currently a principal of Swiftwater Capital, an asset management firm focused on finding value in commodities, stocks and macro investments
