Wealth Intelligence

Should the possibility of low investment returns/ deflation change your investment strategy?

Australia might expect more modest share-market returns in future. But Japan’s ‘Lost Decades’ of investment returns is an excellent example of how astute and independent thinking can yield strong returns in an unpromising market.

Seven recessions

Japan has gone through a number of macro-economic difficulties since 1990; including seven technical recessions.

First Hand Spring Summer15 graph 3 1280pxW

It has been the picture-book of deflation (i.e. negative inflation). And has been a pretty unrewarding place for equity investing.

But inside this deflationary world there are industries and types of companies that have performed relatively well in the last 15 years.

Industry Performance

Breaking the Japanese market into the best four and worst four industries from 2000 onwards provides a useful insight into what worked. And what didn’t.

Industry Return %p.a.
Automobiles  and Transportation Equipment 7.1%
Real  Estate  (Not necessarily REIT) 6.7%
Machinery 4.7%
Foods 4.6%
Nikkei 225 (Benchmark) -0.4%
Electric Appliances  and Precision Instruments -3.4%
Financials -5.0%
Banks -5.0%
IT, Services and Other -5.8%

A more telling indicator of performance … size and value

But moving from sectors to the size and type of stock, gives a better reflection of what has performed well, and possibly a better suggestion as to why.

Index (in descending order of market capitalisation i.e. stock size) Return %p.a. since 2000
TOPIX Core 30 -5.4%
TOPIX Large 70 -0.2%
Nikkei 225 (Benchmark) -0.4%
TOPIX Mid 400 2.3%
TOPIX Small 4.4%

It’s evident during this time in the Japanese equity market that the smaller you were, the better you performed.

Furthermore, the TOPIX breaks companies down into categories of ‘Value’ and ‘Growth’. These are broad definitions based on the Price-to-Book (P/B) ratio of companies, Value having a low P/B and Growth having a high P/B. Whilst this may be somewhat simplified, it is still interesting that, as we broadly perceive it, undervalued companies (i.e. with a low P/B) performed very well.

Buying expensive stocks during sluggish economic times is a great way to lose a lot of money.

First Hand Spring Summer15 graph 4 1280pxW

Conclusion – success comes from independent thinking

Overall, strong equity returns in a time of deflation are not found in large, traditionally safe companies, but rather companies that are small and undervalued.

The takeaway from looking at Japan is, even in a market that has lost 54% since its peak 25 years ago, and has been extremely poor economically, there were still industries and types of investments in the equities’ space that have provided good long-term returns. The ability to capture those good returns was based on having the ability to think and invest independently.

There is much talk of future investment returns in Australia being lower than they have been in the recent past. This is because of very low inflation and very low interest rates, as well as a more benign global economy.

There is a strong case for considering the example of the successes in Japan’s ‘Lost Decades’.

And to manage investments based on the value of the companies and not on their size or reputation.

IMPORTANT NOTICE:  Any advice contained in this document is of a general nature only and has been prepared without taking into account your personal objectives, financial situation or needs.
Because of that, before acting on any advice in this document, you should consider whether the advice is appropriate for you having regard to your personal objectives, financial situation and needs.