Japan is a cautionary tale for investors in the US and around the world. Japan’s stock market boomed in the 1980s and reached very high valuation levels, driven by aggressive money creation by Japan’s central bank. Since then, Japan’s policymakers have tried to resuscitate their stock market with 0% interest rates and aggressive government spending and debt. Sound familiar? If so, please read on for what this means for you as an investor.
Japan’s Recessions
Each of the eight US recessions since 1970 was preceded by an inverted yield curve, i.e., where the 10 year government bond yield fell below the 3 month government bill yield. An inverted yield curve signals a tighter monetary environment that typically leads to the “bust” phase of the “boom and bust” business cycle, as explained by Austrian Business Cycle Theory. That is why an inverted yield curve is one of the most important economic indicators we watch, as we discussed here and here.
However, Japan shows that when short-term interest rates are near 0%, as they are now in the US and most developed countries, interest rates and the yield curve are no longer always useful investment signals.
The chart below shows Japanese 10 year government bond yields as the blue line, along with 3 month yields as the green line. Japanese recessionary periods are shown with the red boxes and numbered in red (US recessionary periods are shaded gray). Japan has had eight recessions since the 1989 peak, compared with only 4 in the US (including the very brief Covid panic recession of 2020).
But only one of those eight Japanese recessions — the first one in the early 1990s — was preceded by an inverted yield curve! All of the other recessions occurred without an inverted yield curve and with both 3 month and 10 year yields at very low levels. Some of the recessions were preceded by modestly rising interest rates, while others were preceded by modestly falling rates. Thus, interest rates and the yield curve have not been useful in predicting Japanese recessions with short-term interest rates at low levels near 0%.
Note that Japan’s Government Debt to GDP ratio was 53% in 1990 and reached 125% in 2003. It is now 266%, the highest of any developed nation. The US Federal Government Debt to GDP ratio is currently at 125% and rising, with no end in sight.
Japan’s Bear Markets
Now let’s look at Japan’s stock bear markets. Japan’s Nikkei stock index rose 500% from 1980 to its peak in December 1989, one of the biggest bull markets in history. At its peak, Japan represented nearly 40% of global stock market capitalization.
Since then, Japan has had three major bear markets with prices falling over 60%: the early 1990s, the early 2000s and 2008-2009. From the 1989 peak, the Nikkei fell a) 63% until a bottom in July 1992, b) 80% until a bottom in April 2003 and c) 82% until a bottom in March 2009. Despite rising over 300% since March 2009, the Nikkei is still trading 25% below the 1989 peak!
The chart below shows the Nikkei stock index as the blue line, with the eight Japanese recessions in the red boxes and numbered. We put red downward arrows to show bear markets that coincided with recessions. For all four of those (numbers 1, 2, 3 and 5), the stock market peaked well before the recessions started. Sometimes the bear markets ended before the recessions ended and sometimes the bear markets ended after the recessions ended.
For the other four recessions (numbers 4, 6, 7 and 8), we put green question marks, to show that stocks were generally mixed during those recessionary periods, which is contrary to conventional wisdom.
Implications For Investors
Based on those historical facts, here are the key lessons investors can learn from Japan:
- Even in a modern industrial economy, stock prices can decline significantly (80%+) and for decades at a time (three decades and counting for Japan)
- Contrary to popular opinion, low interest rates are not always bullish for the economy or stock prices; in fact, they may be a bearish signal of the fragility and risk in the economy and stock market
- High debt levels weaken economic growth and can lead to more frequent recessions and stock bear markets
- Interest rates and the yield curve are not always useful in identifying the beginning or end of recessions or stock bear markets when short-term interest rates are near 0%
- Recessions are also not particularly useful in identifying the beginning or end of stock bear markets
So if interest rates, the yield curve and even recessions are not always useful for identifying — and profiting from — stock bear markets, what is?
Stock markets are ultimately driven by investor psychology, particularly the emotions of fear and greed. How do we determine investor psychology? With technical (chart) analysis.
The chart below shows the Nikkei with bear market periods in red boxes. These periods can be identified simply by observing prices falling below downwardly sloping 250-day moving average (250-dma) lines in red.
Thus, to profit in both bull and bear markets — especially now with interest rates and economic fundamentals losing their effectiveness — investors need to understand and focus on technical analysis to determine bull and bear market trends.
Then, when it is clear the stock market is in a bull market, you can buy stocks and ETFs that go up and outperform in bull markets. And when it is clear the stock market is in a bear market, you can buy stocks and ETFs that go up and outperform in bear markets. It really is as simple as that, as we discuss in this article. But simple doesn’t always mean easy! That’s why we at BullAndBearProfits.com are here to help you navigate and profit from the bull and bear markets to come.
IN THE NEWS: Media and Press coverage has exploded in the last couple of months on Jon Wolfenbarger and BullAndBearProfits.com forecasts and views of major moves in the markets. We’ve summarized some of the stories on our Media Appearances page. Check out those interviews, radio appearances, etc! |