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What to do about a world turning japanese

Negative yields on 10-year bonds tell a nasty story about how the next decade may play out. John Addis explains how to approach it.

"Happy families" wrote Tolstoy in Anna Karenina, "are all alike; every unhappy family is unhappy in its own way". A bull market that precedes a bubble, like a happy family, has a common genesis. The aftermath, however, is unique.

Australia sailed through the Asian Crisis of 1998, the tech stock crash of 2001 and, comparatively, the Global Financial Crisis (GFC) of 2008. And yet Japan is yet to emerge from the bursting of the asset price bubble in 1991.

Japanification is the term used to describe the fear that what has happened since - or, to be precise, what hasn't happened - is about to engulf the West.

Let's set the scene. In Japan's six major cities between 1985 and 1991, commercial land prices rose over 300%. Residential and industrial land almost doubled. The Tokyo land mass became more valuable than the entire United States, and the land beneath the Tokyo Imperial Palace was worth more than California. Plus the food was better.


Decades later, the numbers still amaze. In the 15 years prior to 1990, the Nikkei 225 rose from 4,000 to almost 40,000. This week, it hit a fresh yearly high of 22,472.

Only years later can we fully comprehend the consequences of the crash. Between 1991 and 2001, land values fell 70% and stocks more than halved. The Japanese call the 10-year period ushinawareta jūnen - the lost decade - although it has gone on longer than that.

The Bank of Japan (BoJ) dallied in the chaos, waiting 17 months before slashing rates to less than 0.5% in the mid-1990s. The damage was already done. Consumer confidence crashed and, believing that things wouldn't improve, the Japanese increased their rate of savings, denying the country of the chance that they would.

Bailouts and nine stimulus packages followed. The BoJ, to much guffawing in the west, pioneered an unconventional policy known as quantitative easing - using government-issued debt to buy private assets to prop up prices and recapitalise companies. At the end of March this year, the BoJ was a top 10 shareholder in almost half of all Tokyo-listed enterprises and is the biggest shareholder in 23 stocks.

We can't know the counterfactual but the measures appear to have had little effect. During the 1980s, Japan's economy grew at almost 4% a year. Between 1991 and 2003 it averaged 1.14%. Over the last eight years annual GDP growth averaged 1.07%.

The numbers aren't convincing and yet the pretence continues. "We will support forward-looking economic activity by companies and households," said BoJ governor Haruhiko Kuroda in April, as if the preceding 28 years hadn't happened.

They say it is a sign of madness to keep doing the same thing but expecting a different result. In economics, Keynes is rumoured to have called it pushing on a string. If banks don't want to lend, households don't want to spend and companies don't want to invest, ever lower rates lift the curtain on central bankers howling at the moon. Or, in the case of RBA governor Philip Lowe, at Scott Morrison.

In Japan, the major economic impact of a series of lost decades is an astonishing increase in debt and an equally astonishing appetite in global capital markets to supply more of it. In 1980, Japan's debt-to-GDP ratio was 50.6%. Last year, it hit an all-time high of 254%.

In a Bridgewater report on ‘Why countries succeed and fail’, Ray Dalio argues that Japan's total debt burden is about 449% of GDP, almost double the global average. The debt required to service such sums, even at historically low rates, limits future economic growth and keeps alive companies that should have failed. Chris Harman calls this 'zombie capitalism'.

As with the GFC, the social and political impacts eventually surface. In Japan, these 'unhappy family' aspects take on a local cultural hue.

The Atlantic this week reported on 'modern-style depression' infiltrating Japanese workplaces. Pre-bubble Japan was communitarian and hierarchical. As long as time was served and orders obeyed, career progression was assured.

In the decades since the crash, Japanese businesses have become more Western and capitalist. Employees, rather than relying on the old ways, now have to 'forge their own path'. The failure of some to adjust has led to a very specific form of depression.

Socially and politically, the post-GFC era in the west has been more tumultuous. There are many that would gladly swap new forms of workplace mental illness for Brexit, trade wars, public displays of white supremacy and overt racism and anti-Semitism in political discourse.

In contrast, the economic parallels are striking. In the West, deflation, lower-for-longer interest rates, weak growth, rising inequality and stagnant wages are now commonplace. Exacerbated by bouts of austerity, particularly in Europe, there is little sign of change.

As Mohamed El-Erian wrote in April, "The longer growth and inflation remain low, the more tempted households and companies will be to postpone consumption and investment decisions, thus prolonging low growth and inflation." This is how the world turns Japanese.


The rise of debt with a negative yield sticker offers the best evidence in support of this thesis. If investors are willing to pay governments to look after their money for a decade, what does it say about what that decade will be like?

German and Dutch bond markets now feature across-the-board negative yields. Greece was formerly on the edge of default and at risk of tumbling out of the Eurozone. Two weeks ago, it sold three-month debt at a negative yield and in September the European Central Bank cut rates to minus 0.5%. Every European country's 10-year bond yield is now negative, except for Spain, Malta, Portugal, Italy, Cyprus, Lithuania and Greece.

"Black-hole monetary economics - interest rates stuck at zero with no real prospect of escape - is now the confident market expectation in Europe and Japan, with essentially zero or negative yields over a generation," Tweeted former US Treasury Secretary Larry Summers in August. "The United States is only one recession away from joining them."

In Australia, this makes for an even tougher investing environment. The IMF recently slashed growth forecasts, expecting slower growth in 90% of the globe. China is growing, but at a rate the slowest in almost 30 years, and with its own problems. Expecting GDP growth above 2% when the world's three largest economic regions might struggle to grow for a decade or more is a stretch.


How should members respond?

Our first suggestion is to lower your expectations. A few years ago, I would never have considered a stock like Tabcorp, and not just for ethical reasons. Now, on a yield of 4.5% and the potential of organic growth that might add another few percent, it is indeed a 'rational bet' as Graham Witcomb noted.

The second is an extension of this point. Our renewed focus on stocks with competitive advantages, if not obviously cheap valuations, makes more sense in this environment. Companies that can create new markets and steal market share from competitors don't need a growing economy to do well. Nathan's article on Friday - Watering the flowers and cutting the weeds - lists many examples. We aim to deliver more of them in the months and years ahead.

Finally, remember also that generals are always fighting the last war. Germany's obsession with Weimar Republic hyper-inflation haunts the Eurozone but at least western central bankers have the benefit of Japan's lived experience.

Only in recent years has Japan begun to tackle the impacts of ailing aggregate demand and population decline. Policy responses now include higher levels of immigration and incentives to get more women and middle-aged people into the workforce and keep them there. This is a good move, and 20 years too late.

Western policymakers and politicians, still obsessed with interest rates and tax cuts (which is not economic reform), have the opportunity to learn from Japan's mistakes and focus on boosting aggregate demand. If our generals are to fight the last war, at least in this instance it will be the right one.


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