The Japanese economy has been floating through the abyss of zero interest rates for more than 20 years, unable to recover from the fallout related to its massive real estate bubble that popped in the early 1990s.
The Bank of Japan tried on two occassions to lift its key interest rate off the zero bound, only to have to reverse course and eventually drop rates into negative territory.
Japan’s foray into the zero interest rate environment may have seemed like a one-off years ago, but nowadays it’s merely the new normal.
The European Central Bank and the Swiss National Bank are among those central banks who have dropped their key rate below zero, and as many as 10 countries have at least some debt trading with a negative yield.
So what can we learn from the “Japanification” of financial markets?
According to a recent Bank of America Merrill Lynch note, there are three simple lessons:
- “Big, fat, volatile trading ranges will likely be the norm.” Even though Japan’s stock market suffered through a lost decade as a result of its deflationary bust, that didn’t stop a rally of at least 20% occurring each year between 1990 and 2003. BAML says these rallies and fades are caused by the “3 P’s” …positioning, profits, and policy.
- “Investors should ‘own’ deflation assets and ‘rent’ inflation assets.” You should look to own deflationary plays like dollars, Treasurys and utilities while trading in and out of inflationary plays like commodities, gold and high yield.
- Own “best of breed” stocks. Growth, quality and yield is the way to go. US investors should focus on defensive growth like staples while investors in Europe, Japan and China should move into high-dividend yield names. BAML’s advice, “Buy what you trust.”