The Lesson From Japan

Japan’s stock market is on a roll, largely because expectations have dramatically changed this year about the underlying state of macro for the planet’s third-largest economy. The iShares MSCI Japan Index ETF (EWJ) is up a potent 24% year-to-date. That’s a substantial premium over the 18% gain for US stocks (SPDR S&P 500 (SPY)), for instance. An aggressive new round of monetary and fiscal stimulus that’s weakened the yen and revived animal spirits explains most of the rally. So-called Abenomics seems to be working. Is Japan’s two-decade stretch of disappointing economic performance finally at an end? Possibly, although a few months of improvement vs. 20 years of stagnation is hardly definitive proof. But let’s leave all that aside and consider the larger point of relevance for investing, namely: the surprise factor.

How many investors anticipated Japan’s return to glory? Surely there are a few brilliant (lucky?) ones out there. But most of us were clueless, as implied by the long-running habit of underweighting Japanese equities in asset allocation strategies. Japan, it was widely assumed, was destined to remain a moribund economy, suffering a nearly perfect volte-face from a generation ago, when the Land of the Rising Sun was generally hailed as the exemplar of a new economic order. But a funny thing happened on the way to a sure thing: the forecast fell apart.
Japan’s gradual but persistent fall from macroeconomic grace over the last 20 years convinced almost everyone that there was little point to investing in the country’s stock market in anything more than a token allocation. The wary outlook was certainly understandable, perhaps even rationale. Nobody likes to stick their hand out when knives are falling form the sky, year after year.
It’s still unclear if the recent turnaround in the market’s outlook for Japan is a reliable reflection of what’s coming, or one more head fake on the road to disappointment. But it’s interesting to note that few if any of the usual suspects were talking about the great rebound in Japan late last year. That’s no mystery, since predicting the future is still a mug’s game as a general rule. Japan offers a rather conspicuous example, but it’s hardly an exception. Everywhere you look, there are monuments to failure in the dark art of looking ahead. A few quick examples:
• The US bond market, we’ve repeatedly been told by “experts”, is in imminent danger of collapse. The problem, of course, is that this advice is several years old and so far it’s notable only for being wrong.
• Gold is destined to rise to $5,000 an ounce or higher in something akin to a straight line because hyperinflation is just around the corner. Gold has surged over the last decade, although the bloom has come off the rose in 2013. Why? The fact that hyperinflation is still nowhere in sight may be part of the answer.
• The US dollar is destined to collapse amid “reckless” Fed policies. The reality is far less exciting: a trade-weighted index of the dollar is more or less flat these days relative to the period leading up to the Great Recession.
• The US economy is headed into another recession. That’s true, of course, in the sense that that there’s always another downturn in the business cycle lurking in the future. But for several years now we’ve been told that a new recession is imminent, and so far these forecasts have been perfect… perfectly wrong.
There are many more instances of forecasts that crashed and burned. No wonder that broadly diversifying across the major asset classes (aka keeping radical bets to a minimum) has a habit of routinely generating competitive results vs. the majority of “expertly” managed portfolios that end up charging more and delivering less vs. Mr. Market’s asset allocation. The surprising surge in Japan’s stock market is merely the latest headline-grabbing example of why it’s so hard to beat an expansively defined investment strategy.