Why Japanese equities will continue to dissappoint investors

There is great contrarian logic for buying Japanese equities right now. A great nation on its knees is a buying opportunity. How low can the Japanese bow go? Plus China is an opportunity as a growing market for Japanese goods and services, not an existential threat.

Yet if you look back to the Japanese equity and real estate bubble and crash of 1990 then one thing is very clear. Ever since China took the first steps on its long march to overtake the Japanese economy this has been bad for Japan, not good.

Terms of trade

The terms of trade that had made Japan rich after the Second World War were permanently altered. Chinese labour prices undercut Japan whatever its technological advantage, and the latter in any case gradually transferred to China. Japan might still make key Apple components but by far the bigger assembly plant is in China.

To assume a brighter future for Japanese equities you have to assume that something will change this. Will the yen devalue against the dollar and make Japan competitive again with dollar-linked China? Well at the moment central banks are intervening to keep the yen from going up further. This is not an encouraging trend.

Great nations that have fallen into decline do not automatically then recover after a couple of decades. This decline and fall can be permanent, and history has many examples. The British replacement as the global superpower in the 20th century is one example. Investing in US equities would have been far more profitable for investors.

Surely the natural and manmade disasters that have afflicted Japan this year are also a warning. At first optimists argued that this would just get the government spending and actually boost GDP later this year.

In the event the earthquake is going to be one of the costliest disasters in history with a monetary price tag in excess of $300 billion, quite apart from the human tragedy. Then there is the irradiation of northern Japan and fish stocks. To see this as a Keynesian opportunity is nonsense. It’s an economic disaster.

Unknown unknowns

We don’t know what the unknown consequences will be. It could break the domestic bond market and raise interest rates. Some analysts see that as good for local equities.

But if this crisis bankrupted the nation and imploded the financial system – as it surely would – that would be particularly awful for company profits and also collapse the stock market.

That might be the buying opportunity. British stocks were super cheap in 1940 when Nazi invasion was imminent. Japanese stocks on a price-to-earnings ratio of 12 could still take a considerable dive before reaching a true bottom.

Those who see Japanese stocks as the ‘trade of the decade’ might choose that as their entry point, but not now. Besides we still have not yet seen the sell-off from the two-year old global stock market rally, at least wait for that!