How To Avoid Getting Wrecked Like Japan
And get nice returns while we're at it
Welcome back, folks! If you didn’t have enough of our rambling about yield inversions last week, too bad, this week we’re talking about something that happened over thirty years ago in the equities market!
Super relevant, I know…
Hear me out though, because I think that if you’re not careful you could become a victim of this:
This is the Japanese stock market, specifically the Nikkei 225 index. If you’re somewhat observant, you might notice something wrong with this chart…
The stocks aren’t going up!
Or at least, they haven’t recovered back to their highs in 1990. If you had a lump sum invested within a couple of year window of 1990 you still wouldn’t have a positive return! It would have actually been safer to stuff your money under the mattress than invest it into the Japanese stock market for the long haul.
But like usual, that doesn’t really show the whole picture, and that’s precisely what we’re here to do.
The Valuations Of Japanese Equities:
In this chart, you can see the PE ratio of the Nikkei 225. In 1990 the PE peaked at around 70 times before falling! Essentially, investors at the time were pricing in all the earnings until the year 2060.
Compare that to the more recent PE chart of the Nikkei:
You can see that the valuations are much more “reasonable” (although, I would say anything above 20-25 is still too expensive) in comparison to what they were during the 90s.
Personally, I think this partially explains the negative returns in the Japanese market. With an aging population and few immigrants, it’s difficult to increase profits without raising your margins or unveiling lots of new innovations. And raising margins is only something you can do so much before a competitor comes and ends the party. With such low growth, Japanese equities have had a hard time catching up to those valuations put upon them by investors in 1990. Again, based on 1990 valuations, if there was no growth in earnings we should expect Japan not to fully recover until 2060.
On The Other Hand We Have The S&P 500…
The S&P 500 in contrast to Japanese equities has never seen such high valuations, (aside from once in 2009)
I would say based on this alone, we can say that even the recent exuberance in the markets over the last decade has not been so much that we would have multiple lost decades back to back.
But let’s entertain a hypothetical question. Probably a stupid one at that, but nonetheless interesting.
What if US equities suffered the same fate as Japan with multiple decades of no growth and no recovery to the previous all-time high? Is there anything we could do?
The answer I think, is a resounding yes!
To know why though, we need to take a little trip to one of our all-time favorite books, The Intelligent Investor written by Benjamin Graham.
He describes an idea where an investor purchases stock every month regardless of the share price. This is called Dollar Cost Averaging (or DCA for short).
DCAing into the Japanese equity market drastically changes our return profile.
The CAGR for a lump sum investment into Japanese equities in 1990 is -0.88% with inflation tacked on, that’s a -1.28% CAGR. (Japan has only experienced 13.59% cumulative inflation since 1990)
By contrast, the CAGR we get from Dollar Cost Averaging is a bit harder to calculate because of the lack of good data available, however, it is higher.
We’ll use Portfolio Visualizer to give us a final figure of the size of our portfolio, however, it does not get any Japanese stock data before the year 1996. So we can calculate the percentage drop from 1990 to 1996 and then use the amount we have in 1996 to plug into Portfolio Visualizer.
Percentage loss from 1990 to 1996: 47.9% drop
CAGR from 1990 to 1996: -8.7%
Assume we invest $10,000 USD into Japanese equities at the beginning of 1990 and $10,000 every year thereafter, by the end of 1996 that would be worth $49,448.41, that’s $20,551.59 less than our total $70,000 in contributions.
In the year 2022, our portfolio finishes off at $581,691 after $320,000 of contributions. Not great returns, but at least they’re positive. When we account for the DCAing our MWRR comes out to be 2.94% a year.
It Still Looks Pretty Bleak Though…
We may have gotten away with a positive return, but that doesn’t necessarily mean that our investment grows to something we can retire comfortably on.
I don’t usually like to hate on index fund investing too much, but this data right here shows one of the flaws of the approach. Our fundamental assumption is that the market will always go up, which for all we know, it should. But in the case of Japan, it didn’t, and dollar-cost averaging simply shifts your returns from negative to positive, but not by enough of a margin to have a good amount of money for retirement.
So what to do…
Well, the first most obvious answer and one advocated by indexers, is to invest in a globally diversified equities ETF to get exposure all around the globe. This avoids something like what happened to Japan, from happening to us.
Again, a small caveat here, eventually most markets will mature as they move further into first-world territory where we have a higher risk of flat markets. If a lot of these markets around the globe begin to stagnate, then our growth will be significantly slowed.
You might be thinking “this is a stupid thing to worry about.” And maybe it is, but it’s also possible, so let’s not dismiss it entirely.
The second idea to mitigate this, and something I really don’t hear being advocated anywhere is a buy-write strategy. A buy-write strategy essentially boils down to buying securities and then selling call options on them to generate premiums. During bull markets, this usually underperforms since stock appreciation is at such high levels. However, when markets are flat we can still sell options that then expire worthless thus generating a sort of “dividend.” Historically this has outperformed flat markets in the US by a significant margin.
You can do this by yourself by simply selling options directly on the indexes that you own through your brokerage, or you can invest in a fund that will do it for you (for a fee) like QYLD or XYLD. Both of these funds either invest in QQQ or SPY and then sell call options on the stock that they own.
As of now, I don’t have any other ideas to mitigate the pitfalls of a flat or stagnant market. However, if you have any ideas, leave them in the comments below! I would love to hear them. Hopefully, this article has jogged your brain on the topic and we can continue to explore it. And by the way, if you liked this article, be sure to forward it to a friend, it only takes a couple of clicks of your mouse and helps me out a lot!
With that said…
Until Next Time!
Disclaimer:
All content is for discussion, entertainment, and illustrative purposes only and should not be construed as professional financial advice, solicitation, or recommendation to buy or sell any securities, notwithstanding anything stated.
There are risks associated with investing in securities. Loss of principal is possible. Some high-risk investments may use leverage, which could accentuate losses. Foreign investing involves special risks, including a greater volatility and political, economic and currency risks and differences in accounting methods. Past performance is not a predictor of future investment performance.
Should you need such advice, consult a licensed financial advisor, legal advisor, or tax advisor.
All views expressed are personal opinion and are subject to change without responsibility to update views. No guarantee is given regarding the accuracy of information on this post.