Japan’s 26-year low will shake the conventional investing wisdom to its crumbling foundation. Investing for the long term is one thing. Investing for a long-term that might have to defined as “many decades” is another.
We are not aware of any other developed country stock market that has traded at less than one-fifth of its peak value after 26 years. We hope we never see one again. To put that in a horribly familar context, the equivalent in our market would be DOW 2,800 in 2034.
So should you abandon that tried-and-true investment mantra, buy-and-hold? No. But you should absolutely note that, yet again, the price at which you buy is the single most reliable factor in your long-term return.
Specifically, what are the lessons here?
1. Valuation matters. We are big believers in the advantages of low-cost index investing. Most active traders underperform the market, and the ones who don’t are hard to identify consistently in advance. For a couple of centuries, however, stock prices have gravitated around a relatively consistent mean (15X cyclically adjusted earnings in the US). Investors who have ignored this mean regression or rationalized it away have gotten slammed. This is true at both extremes: low valuations and high valuations.
2. Odds are good that this is a global global opportunity. As crazy as it feels, the time to start overweighting equities is now, when they are below their historical trend. As we noted last week, stocks still aren’t screamingly cheap: After previous bubbles of this magnitude, they have collapsed to below 50% of trend value, which, for US stocks, would be about 5,000 on the DOW (read more here). Unless we are Japan, however, the current prices should provide a compelling long-term return. And, again, the very effectively disguised good news about Japan is that it is so unusual. Japan also peaked at a valuation level that we believe is unprecedented for a major market (including, thankfully, our own).
The Japan news is profound and disturbing, but it does not change the basic equation: price matters. Buy stocks when they are cheap, sell them when they are expensive. For the first time in a couple of decades, stocks are now relatively cheap (US, developed markets, emerging). Now is not the time to abandon a disciplined long-term investment plan.
Below: A chart of US stock values (through March) on cyclically adjusted earnings. They have since, finally, for the first time in more than 15 years, regressed beyond the mean–into undervalued territory. (More on this chart here)
N.B.: Some readers seem to think this or other similar posts we’ve run lately is a “bottom” call. It isn’t. As I’ve said repeatedly, I find the arguments that stocks could drop much farther compelling (see the Grantham link below). I have no idea when or where the market will bottom. Based on a couple of centuries of mean-reversion, I am now more confident that stocks will produce a reasonably long-term return. (“More confident.” Not “certain.”)