Roman Chuyan, CFA
May 5, 2016
“If many remedies are prescribed for an illness, you may be certain that the illness has no cure.”
~ Anton Chekhov, The Cherry Orchard
Most observers agree (at least, those whose experience spans a complete market cycle) that the equity market is overextended. Market valuation is very high, earnings are declining, and the U.S. economy has stagnated. It is the Fed’s and other central banks’ policies that keep bond, stock and other asset prices elevated.
Policies applied by CB’s since the financial crisis of 2007-08 are not really new – they have been tried repeatedly before, in Japan. Since the crash of Japan’s asset bubble in 1990, the country has had more than fifteen stimulus packages. The Bank of Japan has maintained a near-zero interest rate policy for over fifteen years, and implemented nine rounds of QE (the Fed has done three so far). These policies haven’t worked – Japan’s economy has rarely reached 1.25% annual real growth rate since 1990, with frequent recessions. Japan’s experience highlights that monetary remedies of more debt and low (or zero) interest rates can’t cure the real economy.
What about Japan’s stock market? After the initial burst (-56% in three years from 1990 to 1992), Japan’s main stock market index, the Nikkei 225, has continued in a volatile downtrend for over 20 years (see chart).
Nikkei 225, 1990-2016
Source: Yahoo Finance
The ineffectiveness of CBs’ policies in stimulating the real economy has been getting more attention recently. Skepticism is rising, albeit slowly. The ECB and BoJ moving deeper into negative interest rate (NIRP) territory backfired this year: their currencies strengthened and their stock markets plunged. Most recently, when the BoJ announced on April 28th that it’s leaving policy unchanged, Japan’s equities sold off by 3.6% that day and the yen rallied by 3%.
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