Some 35 years ago – ancient times for many investors – one of the biggest stock market bubbles ever was about to burst. I was working in Tokyo near the peak, and I can tell you that few people saw the collapse coming. I offer a summary of what happened as a reminder that the future can look quite different than the past.
Here's a glimpse of Japan at its peak in the late 1980s:
- Japan's economy had grown almost relentlessly from the end of WWII into the early 1980s. Growth had slowed by 1980, but Japan had the highest GNP per capita in the world. Less than four decades before, two of its largest cities had been destroyed, and its economy was in ruins.
- Japan's economic miracle was being studied and copied in the US and elsewhere. Observers saw a dedicated workforce, a national industrial policy focused on economic growth and exports in key sectors, close cooperation between the public and private sectors, and the development of leading-edge technology. In business school, we learned about just-in-time manufacturing, Japan's low cost of capital, its commitment to R&D, and its continual process improvement. Sony and Toyota were perhaps the best-known corporate success stories, but there were dozens of others. And remember: 20 years before that, Japanese products were low-quality, bought only by people who didn't want to, or couldn't afford to, pay for something better.
- Japanese real estate was the most expensive in the world. My favorite example: the 1-square-mile Imperial Palace grounds in the heart of Tokyo was estimated to be worth more than all the real estate in California. (My office was across the street from the Imperial Palace grounds, and it's beautiful – but really?) Japan's total real estate value was about 4 times the US's total, despite the fact the US has 25 times the landmass.
- The Japanese Yen had gained value dramatically relative to the US dollar and other major currencies, yet another sign of the economy's strength. In 1985, a dollar could buy 254 Yen. In 1990, it bought about half as many: 134 Yen.
- The Japanese stock market had soared. The Nikkei 225 index peaked in late 1989 at around 39,000, increasing by about 6x over that decade. The trends discussed above certainly played a major role in the stock market's success, as did uniquely Japanese characteristics like cross-shareholdings, which reduced the supply of shares available for purchase.
And then, seemingly in the blink of an eye, the Japanese economic miracle became a mirage.
The Nikkei 225 stock market index fell by over 50% in 9 months in 1990. But what is far more remarkable is that almost 35 years later, the index has yet to return to its 1989 peak. Please think about how you would feel, as an investor, if your portfolio did not recover for 35 years.
The Japanese stock market crash reflected broader problems in Japan, which – in hindsight – were clear almost a decade before the crash. The economy had begun to stagnate. Some observers call the 1980s, 1990s, and 2000s Japan's lost decades, with growth below global averages for a generation. In sympathy, the real estate market collapsed, fueled by massive borrowing. Japan's overseas investment binge ended.
Why is this history relevant?
Today, US investors seem more certain than ever of a few "truths." US stocks will always be safer and perform better than non-US stocks. The US dollar will always remain the world's go-to currency. The significant increase in US government borrowing will not weaken our economy or diminish demand for US Treasury bonds. We will always dominate the industries that matter – most notably, technology-related sectors.
I don't know whether the US stock market is about to collapse, whether a recession is near, or whether some of the beliefs above will prove false. I learned my lesson in Japan: no one can predict the future. The US has great strengths, and we are far more dominant than Japan ever was. Japan's growth relied far too heavily on debt, much more than we do today in the US.
But isn't it possible that US investors are over-confident? Isn't it possible that a stock market in which seven large stocks contributed almost all the market's growth in 2023 is out of whack? Isn't it possible that US stocks do not deserve the 100% valuation premium over non-US stocks?
The key lessons I learned from Japan – and from crashes I have seen elsewhere in my 30+ years as a financial advisor -- are three:
- The future is unpredictable.
- Cycles can last a long time, but eventually, they end.
- The wise investor diversifies.
I hope you'll heed this advice.
Author's note: the statistics in this blog were sourced from Macrotrends, Wikipedia, Investopedia, The South China Morning Post, and the World Bank.