New on FinoLib · Volume II: Capital Markets
I have just published a new article on FinoLib, my free finance education library: Dot-Com Crash (2000) and Japan’s Lost Decades Explained. It is part of Volume II: Capital Markets. Below is a summary of the topic in plain, expert language, so you can follow the idea even before you open the full article.
10.5 Japan’s Lost Decades
The idea in plain words
Japan’s stock and land bubble burst in 1990 and 1991, leaving firms whose debts were bigger than the value of their assets. Instead of borrowing, they used their cash flow to pay down debt, so near-zero interest rates failed to revive lending. The economist Richard Koo calls this a balance sheet recession. The Nikkei took 34 years to regain its December 1989 record.
Key points
■A firm with ¥100 billion of property and ¥70 billion of debt has −¥30 billion of equity after a 60% fall and needs 8.4 years of cash flow to restore a 30% equity ratio.
■Koo put Japan’s commercial real estate fall at 87% and its corporate net debt repayment at up to ¥30 trillion a year.
■The Nikkei fell 81.9% from 38,915.87 (December 29, 1989) to its March 2009 low.
A closer look
Through the 1980s, Japanese real estate and stock prices rose to extraordinary levels — at the peak, the land underneath the Imperial Palace in Tokyo was reportedly valued at more than the entire state of California. When this asset bubble burst in 1990–91, Japan entered a multi-decade period of anemic growth, persistent mild deflation, and near-zero interest rates that has come to define an entire economic archetype: the balance sheet recession, where over-indebted companies and households prioritize paying down debt over new spending or investment for years, blunting the effectiveness of conventional monetary policy (Volume I’s Part 2) even at very low rates.
Decision rule
Reading rule: after an asset bust, judge whether rate cuts will work by the private sector’s balance sheets, not by the level of rates. If a large share of firms or households have liabilities above the market value of their assets, expect them to repay debt whatever the rate, and expect recovery to need either fiscal spending, fast recognition of bank losses, or both. If balance sheets are sound and the problem is only confidence, conventional rate cuts usually work.
The costliest mistake
Buying the “cheap” market after the first big fall. A buyer at half the Nikkei’s 1989 peak, 0.5 × 38,915.87 = 19,458, still faced a further fall of 1 − 7,054.98 ÷ 19,458 = 63.7% to the 2009 low, and a buyer at the peak waited 34 years to see the index level again, a compound price return of roughly 0% a year. A 50% fall says nothing about value when earnings and land prices are themselves deflating. Value the market on current earnings and the debt overhang, not on its distance from the peak.
10.6 The Dot-Com Crash (2000)
The idea in plain words
The Nasdaq Composite fell 77.9%, from 5,048.62 on March 10, 2000, to 1,114.11 on October 9, 2002, and did not regain its peak until April 2015. Prices had required earnings growth that few firms could deliver. The conflicts of interest behind the hype led to a $1.4 billion research settlement in 2003.
Key points
■At 100 times earnings, a stock needs 17.5% annual earnings growth for ten years just to hold its price as the multiple falls to 20.
■With a 10% required return, the needed growth is 29.2% a year for a decade.
■Ten firms paid $1,387.5 million in April 2003 and separated research from investment banking.
Decision rule
For any stock or sector priced on a story, compute the earnings growth the price requires: (current multiple ÷ mature multiple × (1 + required return)^years)^1/years − 1. If the answer is above about 20% a year for ten years, treat the position as a bet on one of a few winners and size it as you would an option, small enough to lose entirely. If several firms in one sector all need that growth, assume most will fail.
The costliest mistake
Being right about the technology and wrong about the price. The internet did transform commerce, yet a buyer of the Nasdaq Composite at its March 10, 2000, close waited fifteen years, to April 23, 2015, to see that level again, and at the October 2002 low needed a 5,048.62 ÷ 1,114.11 − 1 = 353% gain just to break even. Pay for the earnings a company can plausibly reach, not for the size of the trend it belongs to.
What the full article covers
In the full article I take you through these sections:
■10.5 Japan’s Lost Decades
■10.6 The Dot-Com Crash (2000)
It includes a look under the hood at the mechanics, a clear decision rule, the one mistake that costs people the most, a recap, a reveal-on-click quiz and the official sources behind every figure.
Volume II: Capital Markets
Read the full article on FinoLib
The complete article, Dot-Com Crash (2000) and Japan’s Lost Decades Explained, with every worked example, diagram, quiz and source, is free to read in Volume II, Capital Markets on finolib.com.
Explore the Finance Education Series: Vol. II — Capital Markets · Vol. I — Global Economy · Vol. III — Finance Encyclopedia · Vol. IV — Finance Careers · Vol. V — Personal Finance