The headlines blared: Japan's Nikkei 225 poised to smash its 34-year record! After decades of stagnation, was this finally the long-awaited dawn of a new era for Japanese equities? While the prospect of celebration is understandable, a closer look reveals a more nuanced picture, one painted with shades of caution and historical perspective.
Celebrating solely based on the index reaching a new high is akin to throwing a birthday party for a 90-year-old who's been in a coma since their 20s. Sure, they're technically older, but the journey and missed experiences paint a different story. Similarly, the Nikkei, like the Dow Jones, suffers from a fatal flaw: it excludes dividends and doesn't adjust for inflation. Focusing solely on this flawed metric ignores the true picture of investor returns.
Remember the 1989 bubble? The Nikkei's peak that year marked the beginning of an 80% plunge, leaving investors devastated. While the current climb is encouraging, it pales in comparison to the S&P 500's performance even after accounting for the bubble's distortion. Additionally, using the more accurate Topix index reveals that Japanese stocks are still over 8% below their pre-bubble levels – hardly a cause for unrestrained jubilation.
Over long horizons, the power of compounding dividends is undeniable. In the US, reinvested dividends transformed $100 into $25,000 over 50 years, compared to a mere $6,200 without them. Japan, with its current 2% dividend yield, offers a similar advantage. An investor who bought at the bubble's peak and reinvested dividends would have recovered their losses by 2021, a feat often overlooked in the excitement of price highs.
Deflation may have cushioned the blow of the lost decade in Japan, but it also masked the reality of stagnant returns compared to inflation-adjusted gains elsewhere. Even with deflation, the Nikkei and Topix remain significantly below their pre-bubble levels when adjusted for inflation.
Despite the caveats, there's reason for cautious optimism. Japan is gradually emerging from the shadow of the bubble era. Banks have rebuilt, companies have adjusted, and the deflationary mindset is fading. Corporate valuations are more attractive, and the private sector shows signs of recovery. These, not the index number, are the true reasons for a measured celebration.
