Up until the 1990s, Japan seemed unstoppable, and aimed at overtaking the U.S. economically. Now another Asian economic rival is nipping at the U.S. economy’s heels. That gives rise to the question: What happened to Japan? And what can American investors learn from Japan’s experience? We asked market savants Nicholas Atkeson and Andrew Houghton are the founders of Delta Investment Management in San Francisco:
Larry Light: In the 1970s and 1980s, Japan had a world leading economy. They were an export powerhouse with industry-leading manufacturing sophistication and quality. The Japan Nikkei 225 Stock Market Index reached an all-time high in late 1989. Why?
Nick Atkeson: Although Japan is the third largest economy in the world, 30 years have passed and the Nikkei has not returned to its old high. The reason? Mostly demographics and competition. Japan’s population is shrinking and aging. Japan has one of the highest life expectancies in the world combined with falling birth rates and minimal immigration. Competitively, China, Korea and much of Southeast Asia have become large, less-expensive and capable manufacturers.
Houghton: To stimulate growth and reduce the risk of deflation, the Japanese government lowers interest rates. For the past 25 years, Japan has experienced a falling 10-year government bond rate. Four years ago, their 10-year government bond nominal rate fell below zero and remains near zero today.
Those 10-year bond rates are a measure of expected long-term economic growth. All else being equal, fast growing economies tend to have higher long-term interest rates than slow-growing economies.
Light: How does the U.S. compare?
Atkeson: Like Japan, the U.S. has experienced a downward shift in its long-term economic growth rates and its 10-year U.S. Treasury rate has been trending lower for decades. Unlike Japan, the nominal U.S. Treasury rate never fell to or below zero.
From a macro-economic growth standpoint, the 10-year U.S. Treasury rate is currently signaling that growth prospects are picking up as it has risen from about 0.5% last August to roughly 1.3% this week. Higher interest rates place downward pressure on stock price/earnings multiples. But in the big picture, growth with a little inflation is far better than economic stagnation and price deflation.
Light: What about investors?
Houghton: A forward-looking indicator of growth is the stock market. The S&P 500 is near all-time highs this week.
Light: So it looks like we are in relatively good shape, better than Japan. The S&P 500 has leapt almost six-fold since the 2008 financial crisis. The Nikkei is up a little more than three times. So American stocks did twice as well in the recovery.
Atkeson: Like Japan, the U.S. is facing aging demographics and increased global competition. But comparatively speaking, the U.S. has a more open economic system that allows for faster population growth and more innovation funded by dynamic capital markets and the inflow of many of the best and brightest from all over the world.
High P/E stocks may underperform low P/E, cyclical stocks in a higher interest rate environment, but higher rates are a broad, positive indicator as the expectations for growth are on the rise.
Light: We’ll see how things fare in the rivalry between the U.S. and China. But we do have some hope.
This article originally appeared on Forbes.
