The Beginning of the Longest Bear Market in Modern History

The Beginning of the Longest Bear Market in Modern History

On this day in economic and market history ...

Does the market always come back? Investors in the Nikkei 225 are still wondering. On Dec. 29, 1989, the Japanese analogue to the Dow Jones Industrial Average reached an all-time intraday high of 38,957. Two decades later, the Nikkei's value was still 73% below that mark.

The Washington Post reported on the Nikkei's all-time high with classic irrational exuberance. The article paired a graph of the Nikkei from the start of 1988 to the end of 1989 that showed a near-doubling in value (from about 24,000 points to over 38,000) with the following quote from Japanese trader Kenji Maeda: "The recent quick rises in share prices made investors impatient and feel obliged to buy so that they won't miss the bus."

It is quite difficult to be fearful when others are greedy, but the end of 1989 would have been the best time to flee Japanese markets, which carried major structural weaknesses: Only a quarter of its stocks were ever actually traded. The rest were held by various large business concerns known as zaibatsu, creating a web of interlocking ownership stakes among highly diversified conglomerates such as Mitsubishi, which might have operations in banking, ship-building, electronics, retail, and other various industries. By severely restricting the flow of shares on the market, the zaibatsu artificially inflated prices as greedy investors funneled their resources into fewer and fewer available shares. The Nikkei's average P/E soared past 100 in 1989, a parabolic rise in valuation later imitated by the Nasdaq Composite during the dot-com bubble. After the bullish fever broke, the Nikkei never recovered.

The only comparable bear market in global history is the one that afflicted the Dow for 25 years following the Crash of 1929. It seems all but certain that the Nikkei will go on to break that record. With just over one year to go until the Nikkei hits its quarter-century bear-market mark, the Japanese index remains roughly 60% below its 1989 peak, and since Japanese inflation has been minimal for that period, the difference between the Nikkei's real and nominal losses since 1989 are barely 2% apart. The Dow, by comparison, had already clawed its way back to a mere 25% loss -- closer to 50%, when adjusted for inflation -- by the same point in its bearish doldrums.

To break its bear market within 25 years, the Nikkei would need to more than double by the end of 2014. That sort of growth has never happened in the century-plus history of the Dow, which had a one-year record gain of 67% in 1933 after the worst crash in its history finally ended. To break its bear market by 2019, the Nikkei would still need an annual gain of almost 16% for six straight years. Given Japan's well-known demographic headwinds and its lack of clear and powerful economic catalysts, such growth seems a bit unlikely, to put it mildly.

This market may very well come back given enough time, but it will be too late to save a generation of potential Japanese investors who have watched the Nikkei slide for their entire adult lives.

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