The lessons of Japan's lost decades

The world's major economies have entered a remarkable period – one marked by record-low interest rates, stubbornly slow growth and persistent unemployment.

Investors searching for clues about how to navigate this unfamiliar terrain may want to take their cues from one country that has been experiencing similar conditions for more than 20 years: Japan.

After being a fast-growing powerhouse of industrial innovation through the 1970s and 1980s, the Land of the Rising Sun morphed into the Land of Economic Stagnation at the start of the 1990s. The Nikkei 225 stock average has tumbled more than 75 per cent since it peaked at the end of 1989, while one government spending program after another has failed to ignite vigorous growth.

Could Canada or the United States follow in Japan's footsteps?

Comparisons of this sort are never exact. Some investors disagree with drawing parallels, saying that Japan's shrinking population and slow-moving response to the crisis have no counterpart in Canada or the U.S. Others, however, see similarities and say we can learn from Japan's lost decades.

"We're living in dangerous and difficult times," said Andrew Smithers, economist and chairman of London-based Smithers & Co., which analyzes the G5 group of the world's five biggest economies for investment funds. "What we've got in the G5 countries now is very similar to what happened in Japan in 1990."

Among the similarities that Mr. Smithers sees are overvalued stocks and excessive debt. In Japan's case – as with the United States – the collapse of a massive real estate bubble swamped the bank system with bad loans and threw the economy into a multiyear funk.

At the very least, Japan demonstrates that a quick rebound from a downturn isn't assured, even with prompt government action. "The view that the U.S. will avoid a lost decade because the policy response [to crisis]was quicker and bigger than in Japan is not very convincing when the U.S. economic performance has already been worse than Japan's," Capital Economics wrote in a recent report.

Japan's experience also suggests that many asset classes considered to be havens are far from bulletproof.

Real estate, for instance, proved to be a horrible bet for Japanese investors. The average price of residential land in Japan has fallen 60 per cent since the Nikkei 225's record high, declining every year since 1992.

The domestic stock market proved even more disappointing. All 33 industry groups in Japan's broad Topix index of more than 1,600 companies declined over the past two decades. While a handful of companies such as Canon Inc. and Honda Motor Co. posted gains, it would have taken an astute fortune teller to pick those stocks out from among the hundreds that steadily lost value.

Some assets did far better. Investors would have more than doubled their money by buying Japanese government bonds, as interest rates kept creeping lower. (Bond prices move up as interest rates fall.)

Japanese investors could also have prospered by venturing abroad. Someone who bought the S&P 500 in 1989 and held those stocks until today, would have nearly tripled their money in yen terms.

Precious metals, too, would have been lucrative. Gold moved sideways or down through the 1990s, before beginning an ascent in 2001 that would have more than doubled a Japanese investor's wealth in yen terms.

Even just stuffing money under the futon would have worked out pretty well for Japanese investors as deflation amplified the buying power of cash.

The lesson? Broad diversification works.

A Japanese investor who held government bonds, foreign stocks, precious metals and cash, in addition to domestic shares, would have blunted the Nikkei's fall and even earned a profit. That may not be the most exciting take-away from Japan's experience, but it's one time-tested result that investors should keep in mind as they seek a refuge from today's market weakness.