What Investors Can Learn From Japan’s Great Depression

Monday I wrote about investment lessons from the Great Depression. Chief among these is that if you bought stocks after the Dow (^DJI) declined 50% from its 1929 peak, you did very well in the decade ahead, even though stocks continued to fall for the next 18 months.

In the decade from January 1931 to January 1940 - amidst the worst economic stretch in our history - bonds, real estate, commodities and cash all lagged the long-term performance of the Dow with dividends reinvested.

That’s a surprise to most investors - and a head’s up to those wondering what the heck to do with their money now that the Dow has lost half of its value.

But what about the other Great Depression, the recent one in Japan? In 1989, the Nikkei 225 (^N225) traded above 40,000. Today it languishes near 7,300, 82% lower.

What Investors Can Learn From Japan’s Long Deflation

In many ways, Japan’s long deflation has been different from the United States in the 1930s. There have been no breadlines - or 25% unemployment.

Yet an 82% decline in the market over two decades is devastating even to investors with the longest time horizons. Bear in mind, this example excludes dividends. But still, this is an astonishingly poor performance. What can we learn here?

(Very little from Dr. Jeremy Siegel, incidentally. I pegged him at an investment conference last year for publishing the fourth edition of “Stocks for the Long Run” with nary a word about Japan’s horrendous performance over the past two decades.)

The first lesson, one that becomes increasingly crucial with age, is the supreme importance of asset allocation. A 100% stock portfolio, in my opinion, is too risky for even the hardiest of souls.

I’ve been saying this for decades. But recent events are only just now hammering home the real value of this message.

Japanese investors who diversified into bonds - both foreign and domestic - have enjoyed far higher total returns than those who remained fully invested in stocks.

The other major takeaway from Japan’s multi-decade bear market is the immense value of global diversification. Take a look at the chart below.

In the 1990s, often referred to as Japan’s “lost decade,” Tokyo’s market compounded at just 3% a year for a 35.3% total return. Yet if a Japanese investor diversified into the U.S. market, he would have been well rewarded. During the same period, the U.S. market compounded at 16.7% for a 371% total return.

Global Diversification Worked for Most Japanese Investors

Cynics will point out, of course, that global diversification worked well for the Japanese investor who put money abroad. But what about the hapless U.S. investor who diversified into Japan?

Granted, that investor’s returns would have been lower in the 90s. But it’s important to note that things have often worked out just the other way around.

• In the 1970s, for example, the U.S. market returned just 0.34% a year for a 3.4% total return for the decade. Yet the Japanese market compounded at 16%, generating a 10-year return of 344%.
• Here, the U.S. investor won out. And since it is impossible to know in advance which markets will perform best or for how long, it pays to diversify beyond your own borders.

And here’s a tip: Right now the Japanese market is near a 30-year low. Virtually all Japanese companies trade well below their liquidation value.

If you consider yourself a value investor - if you have a contrarian bone in your body - do yourself a favor and put some money to work in either:

• The iShares MSCI Japan Index (EWJ)
• The Wisdom Tree Japan SmallCap Dividend Fund (DFJ)
• Or both.

It’s true that both Japanese and American stocks are extraordinarily cheap from a long-term perspective. But if history demonstrates anything, it’s that it pays to hedge your bets.

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