Saturday

Nikkei 1989 vs SENSEX Today vs Dow Jones 2007

Japans boom in the 80s no doubt have a special place in history in terms of bubble mania, and serves as a lesson and reminder to investors not to get over excited in bull markets. As they say, even my grandmother can make money during a bull market. As great (or poor if one was bearish) as the fundamentals sound, one should always step back to do a reality check to avoid the trap of being fixated on preconceived notions. Using the Nikkei as the epitome of a stock market bubble, we compared that to boom in global markets recently to see where we are today. Is the great bull market and credit expansion in the last few decades a healthy developmental milestone in our journey to greater heights? Having fallen from the skies in 2007, are we now heading for the heavens ? Very respectable investors in the bull camp cite inflationary pressures and the simultaneous explosive growth in two of the largest nations as the fundamental reason for the coming secular bull market - on top of a host of technical indicators suggesting further upside in the horizon.

Standing back and looking at a 100 year chart of the Nikkei, Dow and Sensex, here are the charts of the Nikkei (since 1914) and DJIA since 1900. (We prefer the linear chart as oppose to log charts)

NIKKEI 1914-2010 Chart (Linear)

Nikkei 1914-2010 Chart

Dow Jones 1900-2010 (Linear)

Dow Jones 1900-2010 Chart

India Stock Market: Sensex 1979-2010

India NIFTY 1979-2010

Using the Nikkei as the epitome of mania, we superimpose other bull markets to appreciate the degree of mania. Ideally we would also like to compare the rate of growth rather than the nominal value.

1. Nikkei versus DJIA

Nikkei DJIA

2. Nikkei versus SENSEX

SENSEX vs Nikkei

• 30 years preceeding the peak: SENSEX has grown 212 times (1980: 100, 2007 peak: 21206). Comparing the 30 years preceeding the peak in the Nikkei, the Nikkei went up 385 times.
• 20 years preceeding the peak: SENSEX - 23.5 times vs Nikkei 20 times.
• The question we ask ourself is:

1. is it possible for NIFTY to continue to defy global fundamentals to make higher highs? Does the high inflation (10%) in India result in a higher nominal stock market. Did inflation fuel Japans boom in the 80s?

Japan faced a severe economic challenge in the mid-1970s. The world oil crisis in 1973 shocked an economy that had become virtually dependent on foreign petroleum. Japan experienced its first postwar decline in industrial production, together with severe price inflation. The recovery that followed the first oil crisis revived the optimism of most business leaders, but the maintenance of industrial growth in the face of high energy costs required shifts in the industrial structure.Changing price conditions favored conservation and alternative sources of industrial energy. Although the investment costs were high, many energy-intensive industries successfully reduced their dependence on oil during the late 1970s and 1980s and enhanced their productivity. Advances in microcircuitry and semiconductors in the late 1970s and 1980s led to new growth industries in consumer electronics and computers, and to higher productivity in pre-established industries. The net result of these adjustments was to increase the energy efficiency of manufacturing and to expand so-called knowledge-intensive industries. The service industries expanded in an increasingly postindustrial economy.Structural economic changes, however, were unable to check the slowing of economic growth as the economy matured in the late 1970s and 1980s, attaining annual growth rates at only 4 to 6%. But these rates were remarkable in a world of expensive petroleum and in a nation of few domestic resources. Japan’s average growth rate of 5% in the late 1980s, for example, was far higher than the 3.8% growth rate of the United States. Despite more petroleum price increases in 1979, the strength of the Japanese economy was apparent. It expanded without the double-digit inflation that afflicted other industrial nations (and that had bothered Japan itself after the first oil crisis in 1973).

In the decades following World War II, Japan implemented stringent tariffs and policies to encourage the people to save their income. With more money in banks, loans and credit became easier to obtain, and with Japan running large trade surpluses, the yen appreciated against foreign currencies. This allowed local companies to invest in capital resources much more easily than their competitors overseas, which reduced the price of Japanese-made goods and widened the trade surplus further. And, with the yen appreciating, financial assets became very lucrative.With so much money readily available for investment, speculation was inevitable, particularly in the Tokyo Stock Exchange and the real estate market. The Nikkei stock index hit its all-time high on December 29, 1989 when it reached an intra-day high of 38,957.44 before closing at 38,915.87. The rates for housing, stocks, and bonds rose so much that at one point the government issued 100-year bonds. Additionally, banks granted increasingly risky loans.At the height of the bubble, real estate values were extremely over-valued. Prices were highest in Tokyo’s Ginza district in 1989, with choice properties fetching over US$1.5 million per square meter ($139,000 per square foot). Prices were only slightly less in other areas of Tokyo. By 2004, prime “A” property in Tokyo’s financial districts had slumped and Tokyo’s residential homes were a fraction of their peak, but still managed to be listed as the most expensive real estate in the world. Trillions were wiped out with the combined collapse of the Tokyo stock and real estate markets.With Japan’s economy driven by its high rates of reinvestment, this crash hit particularly hard. Investments were increasingly directed out of the country, and Japanese manufacturing firms lost some degree of their technological edge. As Japanese products became less competitive overseas, some people argue that the low consumption rate began to bear on the economy, causing a deflationary spiral.The easily obtainable credit that had helped create and engorge the real estate bubble continued to be a problem for several years to come, and as late as 1997, banks were still making loans that had a low guarantee of being repaid. Loan Officers and Investment staff had a hard time finding anything to invest in that would return a profit. Meanwhile, the extremely low interest rate offered for deposits, such as 0.1%, meant that ordinary Japanese savers were just as inclined to put their money under their beds as they were to put it in savings accounts. Correcting the credit problem became even more difficult as the government began to subsidize failing banks and businesses, creating many so-called “zombie businesses”. Eventually a carry trade developed in which money was borrowed from Japan, invested for returns elsewhere and then the Japanese were paid back, with a nice profit for the trader.The time after the bubble’s collapse (?? h?kai?), which occurred gradually rather than catastrophically, is known as the “lost decade or end of the century” (????10? ushinawareta j?nen?) in Japan. The Nikkei 225 stock index eventually bottomed out at 7603.76 in April 2003, moved upward to a new peak of 18,138 in June 2007, before resuming a downward trend. The downward movement in the Nikkei is likely due to global as well as national economic problems.

-source: wikipedia-

Conclusion:

In research, it is said that good research raises more questions than answers. Our million dollar questions are as follows:

1. Will India’s SENSEX make higher high?

2. On the flip side, is it time to long the Nikkei? Traditionally it is said that each cycle lasts for 25-30 years on average. Japan’s Nikkei has gone no where in the last 30 years. What will trigger the next secular bull in Japan? Will it be “real” growth driven by innovation and advances in technology? Or would it be triggered by inflationary factors - eg government printing trillions to devalue to Yen in attempt to be more competitive. This could set Japan on its next secular bull. Looking at other asset classes (gold, agriculture etc), usually bear markets are followed by a (prolong) period of “flat lines” (zig zag going no where) before the defibrillator revives the patient. (This prevents the bulls to ride the rallies - our theory is the market wants to have the least number of passengers onboard before moving!)