Wednesday, December 9, 2009

How You Could Have Made Money in Japan During Their Great Downturn (Lessons for Today's America)

Here's some very instructive stuff from Albert Edwards. I am posting this with the one reminder that there are no constants in the world of human action.

Most traders get caught following supposed correlations that ultimately blow up (Think Long Term Capital Management. Think SubPrime mortgage default rates.) That said, it doesn't mean one has to fly completely blind while investing or attempting to forecast economic trends. I continue to believe that Fed money supply manipulations have a major impact on the economy---though it generally takes time to work through the economy. The 12% to 15% annualized money supply growth rate (Between 9-08 and 2-09) and a dead cat bounce from panic lows has provided quite a bounce to the stock market and some economic indicators, but this doesn't mean they can't reverse trend again--as I fully expect them to do because of the Bernanke's no growth money policy since 03-09. So the lessons that should be taken from the following (and not much more) is a little about timing and that even after some economic data starts to tick upwards the economy can get body slammed again:
Our structural bearishness has never precluded participation in cyclical rallies. We have regularly observed that in Japan, the Nikkei used to enjoy strong cyclically led rallies of 40-50% But with the market still some 75% below its peak, investors tend to forget these rallies and only remember the gloom. A long-only equity investor could have made good money in Japan since the bubble burst.

The secret to making money in Japan was to remember to exit just as most investors had become convinced of a self-sustaining recovery. Investors should have sold as the leading indicators began to turn down. They needed to sell despite protestations from economists that we were set for a mid-cycle pause and strategists telling us that the market was much cheaper than had been seen in recent years. In each case the sanguine voices were proved appallingly wrong. Even moderate fiscal tightening would pitch Japan?s economy back into recession and the Nikkei made new lows. At the stock level, my Quant colleague, Andrew Lapthorne, has demonstrated that in Japan value/momentum strategies needed to be replaced by reversal strategies (buying the losers/selling the winners) ? link. The buy and hold era was crushed by the reality of economic and market volatility.

For Japanese investors, it took some time to learn the new metrics of investing. Today, investors have no such excuse. After all, Ben Bernanke tells us we should learn the lessons of Japan and so we must. Though many commentators want to complicate the investment business, we try and keep our advice as simple as possible. The leading indicators have begun to turn down in the US (see charts below) and so risk assets are therefore dangerous. Almost no-one will be willing to predict renewed global recession and no-one will predict new lows in equities. And with the market so bullish (cover chart) a cyclical failure will come as a crushing blow to sentiment. It is time for caution. It is time to sell.


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