Some people got a kick out of my headline puns, so I thought I would keep the party going this post.

It’s gotten so bad that even the largest wealth manager UBS, had to weigh in on bubble stocks this week and tell their clients not to touch them. You know if they had to come out with broad advice for their clients, there had to be more than a few wealthy clients asking about the trend and having to have their hand slapped by their advisor for even thinking of such a thing.

The financial press, obsessed with “winners” and making us feel as if we are losers for making a loss or not being a billionaire by 25, continue to highlight the improbable fast money being racked up in garbage bankrupt or penny stocks, which I won’t even continue to name by name.

As I have stated I’m past posts, when most people talk about index investing and that no one can beat the market, they are talking about the long term, as in the very long term. Most gamblers and those new to investing can beat an index like the S&P 500 in the short term. That’s not the real challenge, yet this is what has some day traders on a short term high. What is difficult is beating the S&P 500 over the long term for say, 15-20 years. Over a 15 year investment horizon, active managers get beaten by the index in the US for large cap, mid cap and small cap stocks 93%, 94% and 94% of the time respectively. If you come across an advisor or wealth manager that tells you different, you can recommend they read the book Where Are the Customers Yachts, by Fred Schwed.

To just give you an example of how you can beat the market in any year, you don’t have to even be investing sometimes to beat the market. Everyone who just had their savings under the mattress or in a bank account beat the S&P 500 in the years 2000, 2001, 2002 and 2008. It’s not the return in 1 year or 6 months that makes stocks powerful, it’s the unexpected increases that roll in year after year and provide consistent increases over time. That’s what makes people rich over time, not punting in the market, which I’m sure what many UBS wealth managers had to repeat to their clients this week.

That’s not to mention the tax consequences of short term investing, which is taxed as additional income instead of on long term capital gain. If you make under

Long Term Trends

I want to depart from the circus of short term trades to look at long term trends and where things may be headed. Hedge fund titan and Bridgewater found Ray Dalio was quoted this week as saying we may be looking at a “lost decade” for stocks due to the growth prospects we have on the horizon and the hangover from the 10 year bull market which just ended.

When we hear these things, it helps to take a step back and get some perspective. Keep in mind that in the US, our world view, and our investing world view is very US focused. There are returns outside of the US, it just so happens that they haven’t been that great in the past 5 years. US big tech has dominated the rally both domestically and globally. Will this continue? Maybe, but we can’t be sure, that’s where the excitement of investing and dealing with the future comes in.

I have discussed demographics and their slow, behind the scenes drag on growth in previous posts. I came across a few interesting facts the other day that brought me back to these topics and what how we may be able to invest if we indeed are looking at a lost decade of stocks.

The facts were that developed countries will be losing 25 million people from their working age population from now until 2030 while emerging economies will add 470 million people of working age over that same period. This data was pointed out by a large investment bank looking to capitalize on long term themes.

What this means is that even if we continue to innovate and become more productive, we may be looking at a continuation or even marked slowdown, of the slow growth trajectory many wealthy countries have been on in the past 20 years. Post war, the US GDP grew at an average annual rate of about 3%. Since the year 2000, it has been only around 2%.

Some argue that this is due to conscious lifestyle choices that consumers are making and the shift away from a consumerist mind set as argued in this article from The New Yorker. Although this may have some valid points and makes intuitive sense, demographics will still play a role because the less workers there are, the more each worker has to produce in order to maintain a given level of GDP. Where has this been happening in the world? One answer is Japan.

Japanification may not be a Dirty Word

Much of the reading about Japan’s economy in the past 25 years has leaned towards pity and confusion. If you are examining demographics however it makes sense.

Japan’s working age population peaked around early 1995 and a stock market bubble had popped about 6 years before that. Then came a recession in the US which impacted their biggest trade partner. The subsequent 10 years after the Nikkei bubble burst and the moribund economy that followed is known in Japan as the “lost decade”. Source: St. Louis Fed

Besides a fall in workers there are valid reasons that the stock market came down as well. To add to the exceptional cases in Japan, it’s the only major stock market that has not climbed back from when it’s bubble popped. On December 29, 1989 when the Nikkei 225 peaked, many stocks had a P/E of 60. The shakeout to a more normal market took about 10 years and then a policy of a weak currency took its toll on the return in dollars. So in US dollar terms on paper, the Nikkei has looked like a terrible investment since then. Despite this it has approached a valuation that is much more on par with other developed country indexes with a P/E around 14 today.

In fact, if you were to compare the performance of the Nikkei 225 to the S&P 500 over the past 5 years you would notice that their returns aren’t that far apart.

Source: Yahoo Finance

Why has no one noticed this? Because at the same time that the Nikkei was picking up steam, Abenomics was dictating a weaker currency to continue to drive exports. During this same period the value of the yen dropped by almost 40%, wiping out much of the gains you see above in dollar terms.

Source: St. Louis Fed

While this was going on in stocks, nominal GDP has remained the same in Japan for the last 20 years but GDP per capita has continued to increase at around 1%-2% per year. This means that a smaller amount of population and workers are producing the same value of goods and services did when they had millions of more people.

The changing in demographics has offered opportunities as well. Japan is the number 3 pharmaceuticals market in the world, punching above its weight due to its relatively rich older population. A huge amount of domestic savers that needs liquidity has enabled the BOJ to keep rates low and debt to GDP high, defying skeptics for over a decade that said the country would crumble under the weight of its debt.

What This Means for the US

There are lessons to be learned in the case of Japanification and they aren’t all bad.

• Slow Growth Doesn’t Mean No Growth – Individuals have continued to get wealthier while the economy as a whole seemed stagnant.
• There are Opportunities in an Older Population – Healthcare May continue to be a major player and outperform other sectors in the rich world as we see more countries move towards a more Japanese style of demographics.
• Tech Will Continue to be Important – New ways to communicate for health (telemedicine) and more convenient ways to purchase goods (e-commerce) will only increase in importance. This spells good news for the continued outperformance of sectors like the tech heavy Nasdaq 100 in the medium term.
• Our Bubble Isn’t Massive – Better to have stocks go sideways for a while then to have them going down. Although the P/E for the S&P 500 is high by historical standards at 22.6, it’s not at Japan 1989 levels, so any reversion to the mean will not be as painful.

So despite losing workers and the potential for high debt and lower GDP growth, there is a case to be optimistic for the US and other developed countries in the coming decade. Additionally, don’t forget about those 470 million new workers in emerging countries, they will offer long term opportunities for US investors, especially if the dollar weakens (which it is likely to do in the medium term) and the market continues on a sideway path. So cheer up, there is more to come than just speculating on bankrupt companies and buying negative yielding debt.

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