What If We Aren't Japan?

Two recent publications take issue with our declaration that we are Japan.

First, we should clarify our position. Our original blog post declaring that "we are Japan" (dated 3/18/2009 - nearly 18 months ago) implied what we meant, which can be paraphrased by the Mark Twain quote that "History doesn't repeat itself, but it does rhyme." To be more specific, while we acknowledge that there are a multitude of meaningful differences between the Japan experience that began in the late-'80s and our present condition, we believe there are many similarities. Among the most notable:
<> We have suffered a systemic financial crisis.
<> It has inflicted substantial and lasting damage to asset prices, employment and the economy.
<> A return to growth in asset prices, employment and the economy will take years, not months.

What we were not (and are most assuredly are not) suggesting is that the US is identical to 1990 Japan.

With that disclaimer, we submit for your consideration the two publications. First is a research piece published by Credit Suisse on August 19, 2010 and entitled The US is not Japan. Unfortunately, due to legal and/or regulatory issues, we are not at liberty to republish or share the publication and have been unable to find a copy of it at the Credit Suisse website to which to point you.

However, we can offer an overview/summary. Indeed there are meaningful differences between the US today and Japan in 1990. Among the more persuading differences were the fact that US policymakers have been much more proactive, that US banks are not in as poor shape as their Japanese counterparts were, and that Japan's demographics were much worse than are ours.

In its ability to convince the reader that the US is in a much different position than Japan was in 1990 the paper is most effective. Our read, however, is that the paper falls far short of convincing us that the US will avoid a multi-year period of weak economic performance, a massive increase in government debt, and strong deflationary pressures.

The second publication appeared as a "Last Word" guest column in this past Monday's FT. It was authored by Edward Chancellor, a member of the asset allocation team at the global investment firm Grantham, Mayo, Van Otterloo & Co.

Mr. Chancellor writes that "the only rational explanation for the extremely low yields on Treasuries" is that "the US economy is doomed to a combination of lacklustre growth and a declining price level in years ahead."

His arguments are compelling. In particular, a referenced essay from the latest Bank for International Settlements Quarterly Review entitled Debt Reduction after Crises points out that Japan's deflationary experience is the exception rather than the rule in the history of banking crises.

A competent investment strategist should continuously check his/her outlook against the reasonable outlooks of those who may not agree. In doing so, we readily confess that we may be wrong. There may indeed be a recovery already underway that lifts our economy out of this quagmire and results in more favorable economic activity and therefore higher bond yields. That is one of the primary reasons we build diversified portfolios - one can never be sufficiently certain of an investment outcome to go 'all in'. Moreover, one must consider both the probability of being right and the magnitude of being wrong. For example, one could have a 99% probability weighting on an outcome but, if the impact of that 1% adverse outcome is sufficiently negative, it must be respected.

At this moment we see little evidence of a recovery, either in the concurrent data or in the economic history books that have examined financial crises. In doing so, we continue to point to Hoisington Investment Management's excellent Quarterly Review and Outlook as some of the best work in this area.

While we continue to maintain select exposure to equities that would benefit from an outcome less dire than we expect, we also continue to hold substantial exposure to those assets that would most benefit from the sluggish (if not deflationary) environment we believe is most likely in the months and years ahead.