The Unloved Part Two: Japan

Written by John Osbon on August 17, 2015

Two weeks ago we talked about the four year 40 percent decline in gold, making it one of the world’s most thoroughly unloved asset classes. Gold’s big decline is a sure signal to rebalance. But gold’s not the only asset looking for love in all the wrong places. This week we have an even worse performance story: zero return after 25 years. Which big market did this and what does it mean for you?

Japan: rising sun, setting stocks
That’s right. If you had invested in Japan 25 years ago your return would have been just a fraction over nothing per year. As in zero. The Nikkei peaked at 38,957 on New Year’s Eve 1989, closing last week at 20,809. Dividends have made up for the difference, bringing the total return “up” to nada.

Too big to ignorehokusai
Japan is a big economy. At $6 trillion it’s the third largest cap market in the world after the US (18T) and China A Shares (9T), and just ahead of the United Kingdom (6T) and Germany (2T). It’s a bit of an enigma too, with pluses and minuses in tantalizing balance. For example, Japan as a country is highly indebted. Yet Japan is tied with China as largest holder of US Treasury bonds at $1.2T. Its population is among the oldest in the world, yet it is home to innovative global behemoths Toyota, SoftBank and Takeda.

What we notice most about Japan is how its track record of returns is so far below its long term expected return. Given its size and technological sophistication, we would expect Japan to perform something like the US or Germany. The broad US market is up about 10x since 1989. Japan is up 0x.

Getting (back to the) mean
In the language of statistics, we expect asset classes to “revert to the mean” – that is, trend toward long term averages of similar assets. If this occurs for Japan it will happen through multiple years of high returns. Perhaps this has already started, as the Nikkei is up more than 100 percent over the last three years.

Japan’s big lag behind long term historical returns makes it an ideal candidate as a “factor” for portfolio management. Factors are added where performance is out of synch with long term averages. Factor examples we have used are financials, technology and now Japan.

We don’t know if this revival will happen for Japan, or how it will come to pass. We’ll find out after the fact. But we see enough evidence to add a small additional allocation to catch that reversion to the mean.  If it happens you can expect generous returns from even a small Japan weighting.

John Osbon – josbon@osboncapital.com


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