MARKET COMMENT
Lessons From The Japanese Stock Market

By James Carlisle
February 6, 2002

Great Titchfield Street, London -- The last couple of years have been pretty hairy in the stock market, but we're always calmed by data showing that, over the long term, shares will win through. So this morning's news that the main Japanese stock market index, the Nikkei 225, has hit an 18-year low is more than a little disconcerting. It gets even worse when you look at the detail. This morning the index stands at 9,421. It was last there back in February 1984 but, in the meantime, it hit a peak of over 39,000 back in 1989. What's all that about?

Well one point is worth making right away. The Nikkei 225 is a silly index. Its value is basically calculated by taking the average share price of its constituent stocks, so that a piddling printing company might have a higher weighting than, say, NTT DoCoMo. The effect of this is that the index is not the 'market portfolio' and it therefore doesn't actually reflect what is actually happening to the average yens invested in the market.

To make matters worse, the index also underwent a major reshuffle in April 2000, when a greater technology weighting was introduced (indeed that was partly the point of the reshuffle). Let's face it, April 2000 was not a good time to have increased your technology weighting.

So we can look at a more sensible Japanese index, like the market value weighted Nikkei 300, but this doesn't look much better. The index was established in October 1982 with a value of 100, it stood at 150 in February 1984, peaked at 520 in 1989 and now stands at just 182. So, while the Nikkei 225 has gone sideways, the Nikkei 300 has managed an increase of 21% (or about 1% per year). These figures don't include dividends, but it's hardly scintillating stuff.

You could also say that the Japanese economy has had its own problems (it certainly has) and that the stock market prices get distorted because of substantial cross shareholdings between companies, but it doesn't really wash. If Japan has had these problems, then it's at least conceivable that they could happen elsewhere.

In any case, it's not just Japan. The Dow Jones index in the US stood at 874 on 31 December 1964 and had managed an increase of only 1 point, to 875, by the end of 1981 (like the Nikkei 225, the Dow is also not a market value weighted index, but let's not worry about that). It's harder to assess things in the UK because of all the inflation we've had, but the CSFB Gilt-Equity Study shows a real equity index value in the UK of 21,318 in December 1958 and just 18,010 at the end of 1974 (and those figures include dividends).

Of course, I'm being selective about the data, picking out the worst times, and we should remember that at most other times shares have been a terrific investment. It's also fair to say that, generally speaking, alternative investments such as cash wouldn't have done very well over the 'bad periods' either. Besides, we can't predict when the bad periods are going to be, so if you want to catch the plentiful good periods, then you have to be prepared to land in a bad period. But there is an inescapable conclusion to reach.

Shares can go down. They can go down a long way and, just when you thought they couldn't go down any more, they can just keep on falling.