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WHAT DOES IT ALL MEAN?
The lessons of market history are clear. Styles and fashions in
investors’ evaluations of securities can and often do play a
critical role in the pricing of securities. The stock market at
times conforms well to the castle-in-the-air theory. For this
reason, the game of investing can be extremely dangerous.
Another lesson that cries out for attention is that investors
should be very wary of purchasing today’s hot “new issue.”
Most initial public offerings underperform the stock market
as a whole. And if you buy the new issue after it begins
trading, usually at a higher price, you are even more certain to
lose. Investors would be well advised to treat new issues with
a healthy dose of skepticism.
Certainly investors in the past have built many castles in
the air with IPOs. Remember that the major sellers of the
stock of IPOs are the managers of the companies themselves.
They try to time their sales to coincide with a peak in the
prosperity of their companies or with the height of investor
enthusiasm for some current fad. In such cases, the urge to get
on the bandwagon—even in high-growth industries—
produced a profitless prosperity for investors.
The Japanese Yen for Land and
Stocks
So far, I have covered only U.S. speculative bubbles. It is
important to note that we are not alone. Indeed, one of the
largest booms and busts of the late twentieth century
involved the Japanese real estate and stock markets. From
1955 to 1990, the value of Japanese real estate increased more
than 75 times. By 1990, the total value of all Japanese
property was estimated at nearly $20 trillion—equal to more
than 20 percent of the entire world’s wealth and about double
the total value of the world’s stock markets. America is
twenty-five times bigger than Japan in terms of physical
acreage, and yet Japan’s property in 1990 was appraised to
be worth five times as much as all American property.
Theoretically, the Japanese could have bought all the
property in America by selling off metropolitan Tokyo. Just
selling the Imperial Palace and its grounds at their appraised
value would have raised enough cash to buy all of California.
The stock market countered by rising like a helium balloon
on a windless day. Stock prices increased 100-fold from 1955
to 1990. At their peak in December 1989, Japanese stocks
had a total market value of about $4 trillion, almost 1.5 times
the value of all U.S. equities and close to 45 percent of the
world’s equity-market capitalization. Firm-foundation
investors were aghast at such figures. They read with dismay
that Japanese stocks sold at more than 60 times earnings,
almost 5 times book value, and more than 200 times
dividends. In contrast, U.S. stocks sold at about 15 times
earnings, and London equities sold at 12 times earnings. The
high prices of Japanese stocks were even more dramatic on a
company-by-company comparison. The value of NTT
Corporation, Japan’s telephone giant, which was privatized
during the boom, exceeded the value of AT&T, IBM, Exxon,
General Electric, and General Motors put together.
Supporters of the stock market had answers to all the
logical objections that could be raised. Were price-earnings
ratios in the stratosphere? “No,” said the salespeople at
Kabuto-cho (Japan’s Wall Street). “Japanese earnings are
understated relative to U.S. earnings because depreciation
charges are overstated and earnings do not include the
earnings of partially owned affiliated firms.” Price-earnings
multiples adjusted for these effects would be much lower.
Were yields, at well under ½ of 1 percent, unconscionably
low? The answer was that this simply reflected the low
interest rates at the time in Japan. Was it dangerous that
stock prices were five times the value of assets? Not at all.
The book values did not reflect the dramatic appreciation of
the land owned by Japanese companies. And the high value
of Japanese land was “explained” by both the density of
Japanese population and the various regulations and tax laws
restricting the use of habitable land.
In fact, none of the “explanations” could hold water. Even
when earnings were adjusted, the multiples were still far
higher than in other countries and extraordinarily inflated
relative to Japan’s own history. Moreover, Japanese
profitability had been declining, and the strong yen was
bound to make it more difficult for Japan to export. Although
land was scarce in Japan, its manufacturers, such as its auto
makers, were finding abundant land for new plants at
attractive prices in foreign lands. And rental income had been
rising far more slowly than land values, indicating a falling
rate of return on real estate. Finally, the low interest rates
that had been underpinning the market had already begun to
rise in 1989.
Much to the distress of those speculators who had
concluded that the fundamental laws of financial gravity were
not applicable to Japan, Isaac Newton arrived there in 1990.
Interestingly, it was the government itself that dropped the
apple. The Bank of Japan (Japan’s Federal Reserve) saw the
ugly specter of a general inflation stirring amid the borrowing
frenzy and the liquidity boom underwriting the rise in land
and stock prices. And so the central bank restricted credit and
engineered a rise in interest rates. The hope was that further
rises in property prices would be choked off and the stock
market might be eased downward.
The stock market was not eased down; instead, it
collapsed. The fall was almost as extreme as the U.S. stock-
market crash from the end of 1929 to mid-1932. The
Japanese (Nikkei) stock-market index reached a high of
almost 40,000 on the last trading day of the 1980s. By mid-
August 1992, the index had declined to 14,309, a drop of
about 63 percent. In contrast, the Dow Jones Industrial
Average fell 66 percent from December 1929 to its low in the
summer of 1932 (although the decline was over 80 percent
from the September 1929 level). The chart
The Japanese
Stock-Market Bubble: Japanese Stock Prices Relative to Book
Values, 1980–2000
shows quite dramatically that the rise in
stock prices during the mid-and late 1980s represented a
change in valuation relationships. The fall in stock prices
from 1990 on simply reflected a return to the price-to-book-
value relationships that were typical in the early 1980s.
The air also rushed out of the real estate balloon during the
early 1990s. Various measures of land prices and property
values indicate a decline roughly as severe as that of the stock
market. The bursting of the bubble destroyed the myth that
Japan was different and that its asset prices would always
rise. The financial laws of gravity know no geographic
boundaries.
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