Late last week I was talking to a client who mentioned it had been a while since we last sent out an Insight. I explained, as I often do, that we only write when we feel there is actually something worth writing. Of course the very next morning we come in the office and Japan’s market is down more than 7 percent. That is a big drop in one day and speaks to the issue we discussed in our last Insight: This market is increasingly fragile.
Some background may be necessary here for our clients that do not follow the markets as closely as we do. The market in Japan has been on a tear, up more than 40 percent year-to-date in local currency (that gain has been almost halved by the drop in the yen for non-Japanese investors). All of that return is based on the extremely aggressive measures taken by the Japanese government to kick its economy out of the deflationary spiral it has been in for more than twenty years. They have undertaken a policy of fiscal and monetary stimulus of proportions that are somewhat mind-boggling. Interest rates in Japan have been at or near zero for as long as I can remember, and they have tried many rounds of quantitative easing which has been as ineffective there as it has been here in the United States. But now they are purchasing their own debt at a rate that is just barely slower than what our Federal Reserve is doing at home. However, Japan’s economy is approximately one third as large as the U.S., so in relative terms they are printing yen at three times the pace we are printing dollars.
Thus far all this activity has done little other than slightly help exports (a weak yen makes Japanese products cheaper for non-Japanese) and create a potential bubble in their stock market. To paraphrase Winston Churchill, trying to promote lasting economic growth through fiscal and monetary stimulus is like trying to stand in a bucket and lift oneself up into the air with the handle. It does not work, because any money borrowed today must be paid back tomorrow and while they can have short bursts of growth, ultimately they are digging a larger and larger hole. Japan is living proof of this. They have accumulated more debt relative to their GDP than any other nation on earth by trying to stimulate themselves out of their deflationary spiral for more than twenty years. Instead of learning their lesson they have decided that all the other attempts were just too small. They will do not just more of the same, but a boat-load more of the same, and hope for a different outcome.
But, thankfully it is not our job to fix Japan; it is our job to manage money. Whenever stock market values rise for reasons other than the fundamental improvement of the companies whose stocks are represented in the market, it is illusory and will end badly. Japan’s market was bound to have a day like Thursday, and there will probably be more. Prudent investors do not get caught up in such folly. Knowing what you own and why you own it is critical, and there had better be some real intrinsic value backing your investments or one day they will simply go “poof.” Bubbles always burst, and chasing them believing one can know when to get out is very risky. The relationship between risk and return is one of the most misunderstood and over-simplified relationships in all of investing. More risk does not guarantee more return; it only guarantees more risk. Some investors learned that in a very sudden and painful way on Thursday. Thankfully for you, we already knew that at Iron Capital.
On a personal note, I hope all of our friends and clients had a happy and safe Memorial Day weekend. Our thoughts and prayers remain with our friends in Oklahoma, and we urge everyone to remember those impacted by the storm in the days and months ahead. For those looking for ways to give we would suggest two organizations for consideration. One is the Alvis Foundation, which is a private family foundation located in Norman, Ok., now accepting public donations to assist in grassroots efforts following natural disasters and unanticipated events resulting in severe hardship. They have committed to sending 100 percent of any donations directly to victims of this storm. The other is UMCOR (United Methodist Committee on Relief). UMCOR is a larger organization run by the United Methodist Church whose full administrative cost are funded by the church, allowing 100 percent of any money received to go to victims of natural disasters. Of course there are many other worthy ways to give, including larger organizations like the American Red Cross and the Salvation Army.
Chuck Osborne, CFA