What the Japanese bubble taught me

THE Japanese economic miracle hit its zenith in 1989. A period of sustained economic prosperity, and strong corporate profits led to a buoyant property market, a spirited stock market, and countless crazy stuff.

During a business trip to Geneva, once my cab driver learnt I was a fund manager from Tokyo, he praised endlessly the land of Toyotas, JVCs, Nissans, and Sonys. He then asked my view on the warrant of a small Japanese diesel engine manufacturer that he had just bought.

In 1988, I was invited to a “US$10,000 evening”. Brokers at that time made so much money that this extravagance was not even worth a thought. As it was not possible to even spend 10 per cent of the budget on delectable Kobe beef and lobsters, club-hopping in Ginza was the only creative way to do so.

Beyond the Ginza clubs were other crazy clubs: Golf clubs. Memberships were going for US$500,000 to US$1.5 million for courses 90 minutes’ drive from Tokyo. For US$250,000, you can secure the privilege of driving 2.5 hours each way to play 18 holes. Banks joined in the party, offering 80 per cent loan-to-valuation ratios. One could even trade 400 golf memberships like stocks.

Naturally, corporate Japan decided that it must also have a piece of action in the stock market. Every other listed company took out bank loans at 3 to 5 per cent per annum to punt stocks.

Neither policymakers, academia, nor corporate Japan had warned that a real estate meltdown would sink the Land of the Rising Sun. Japan’s property and stock market bubble started to unravel in 1990, and its real estate market remains moribund after 30 years of deflation.

This experience taught me many things about bubbles, the hubris and irrationality of policymakers, and the psyche and behaviour of investors in exuberant times.

Common bubble characteristics

What is confounding is that professional investors do not seem to have learnt the lessons from history. As a group, we behave like lemmings once every decade. Why? This question defied logic until behavioural finance professors posited our flawed DNA is the cause. Combining into greater numbers offered homo sapiens in millennia past the best chance of survival when confronting a threat. Crowding together provided comfort and increased the odds of survival.

In investments, however, crowding creates bubbles and is a recipe for disaster. If the thesis is true, then fighting our DNA is critical to resist getting sucked into bubbles.

At the risk of oversimplification, we can broadly group the contributory factors of bubble formation into 4 categories.

First is hubris aplenty from both professionals and the uninitiated. The cab driver in Geneva and fund manager in Nihonbashi district both extrapolated current good times into near infinity with reckless abandon.

Second, bubbles are caused by ample cheap capital. Banks charge razor-thin spreads and demand minimal collateral, which fuels more speculation in financial markets.

Third, central bankers relying on money printing to tackle every major economic problem are also at fault.

Finally, retail investors are often the last group to push prices to stratospheric levels. As they lack the experience and analytical skills, they usually cannot discern the difference between investing and speculation.

China’s bubbles

China’s phenomenal economic success, capital controls, and a high household savings rate of over 30 per cent had fuelled the Chinese property market’s bull run for 2 decades, with nary a meaningful speed bump.

The People’s Bank of China (PBOC)‘s major worry is bank loans to developers, rather than mortgages. Alive to the risk of a Japan-style systemic crisis if home prices were to crash, it issued the draconian “3 red lines” policy in the autumn of 2020. Almost immediately, banks were forced to reduce their exposure to the developers and developers were compelled to reduce their leverage. The PBOC can now afford to ease as it had tightened before things got out of hand.

Supported by ample liquidity in China and Wall Street, China initial public offerings (IPOs) showed signs of euphoria in 2020 to 2021. It was common in China that IPOs would begin trading at 200 to 500 per cent of the offering price. Across the Pacific Ocean, Chinese American Depositary Receipts (ADRs), regardless of their profitability or management integrity, were snatched up on Wall Street. Luckin Coffee and Didi are just 2 well-known examples. Missfresh, a grocery e-commerce company, deserves a mention. Debuting only a year ago at US$13, it was trading at just 12 US cents at end-July! The IPO game is probably over.

Until just 5 quarters ago, China Internet companies had been the place to crowd for comfort and gravity-defying returns. They have since been beleaguered by a series of regulatory crackdowns. Bulls have argued in Q2 2022 that the regulatory crackdown is largely over. Is that so? The Wall Street Journal reported as recently as Jul 14 that senior executives of Alibaba have been called up for investigations of serious data breaches. Didi was fined US$1.2 billion on Jul 21 for multiple data breaches. Tencent, the world’s largest video game company, failed to obtain approval for any of its new games in the last 2 rounds. China's draft amendments to its Anti-Monopoly Law have yet to be promulgated, and the draft law on selling drugs and dishing out medical advice on Internet platforms is only at the consultation process.

Bubbles in the US

Liquidity has propelled US Treasuries, stocks, real estate, crypto, wages, and the consumer price index to levels not seen in decades. The Fed’s balance sheet has ballooned to US$9 trillion. New investing styles such as meme investing, disruptive-technology investing, FAANGs (Facebook, Amazon, Apple, Netflix, Google) and cryptocurrencies were regarded as the new zeitgeist.

Now, cryptocurrencies supposedly designed to protect investors from fiat currency inflation and to preserve value during a financial crisis have done the extreme opposite, with lenders and brokers going bankrupt.

Inflation is haunting many countries. As bubbles in various asset classes burst, is recession the next devil to haunt us, especially in the developed world? I think we are finally paying the price for a lack of imagination, as well as weak discipline in turning to the money printing press to tackle our economic and social problems.

It is baffling why investors still have confidence in US Treasuries, as the real yield is still a negative 6 per cent after inflation is taken into consideration. Loose monetary policy, high inflation, massive debts, trade deficits, and recessionary fears would usually cause the country’s currency to collapse. But the US greenback is appreciating against almost every currency in the world.

One reason is how the US dollar is the world’s only viable reserve currency. But it still does not make economic sense for the dollar to continue to stay almighty, especially in contrast with countries that have been maintaining fiscal and monetary discipline in combating Covid.

Changing of the guard

Will the stock icons of the last bull market continue to be tomorrow’s icons? Not only will new, powerful investment theses be needed, but earnings will also have to bounce back strongly. Thus far, there are no signs of either.

Based on my experiences, when an investing style changes, few managers can adapt decisively to the new investing style. Therefore, an investing style change would usually bring about a “changing of the guard”. Investors such as Ark Invest’s Cathie Wood, Hillhouse’s Zhang Lei, and Tiger Global’s Chase Coleman are the legends of our time. I am sure many investors, including this writer, will watch with great interest whether lessons have been learnt, or if the comfort of the crowd continues to beckon.

Wong Kok Hoi is founder and chief investment officer of APS Asset Management.