By: Julio Cacho, PhD & Juan Carlos Herrera
Today’s investors are wildly enthusiastic about America’s all-conquering technology companies, such as Google, Apple, Facebook, and Amazon. These companies are either shielded from the threat of takeover by special shareholder structures or, in the case of Amazon, have persuaded investors that long-term growth is more important than short-term profits. Other countries only wish they could create technology giants with the same reach as one of America’s titans.
The U.S. stock market is around 50% of the global stock market, but there are worrying parallels to the way that Japan dominated the index in the late 1980s, when the Japanese stock market was 44% of the global stock market. Investors were enthusiastic about Japanese multinationals like Toyota and Sony; the talk back then was about the rest of the world needing to learn from the Japanese model. Japan’s companies were free from the threat of takeover and were able to pursue long-term plans without worrying about short-term profits. Unfortunately, the Japanese stock market was relied on too heavily, eventually crashed, and has not recovered since then. During the past 30 years Japan’s global market capitalization went from 44% to around 8.1% today!
Global Market Cap 1989
Source Vanguard: https://investor.vanguard.com/etf/profile/portfolio/vt
Global Market Cap 2018
Source World Bank https://data.worldbank.org/indicator/CM.MKT.LCAP.CD?start=1989&year_low_desc=true
Do such parallels mean that America is doomed to follow the same path as Japan? Not necessarily. Investors may grant a higher valuation to a country’s stock market because they perceive it to have attractive fundamentals. The American market is not as highly valued as Japan’s was in the late 1980s, when skeptics were told that Western valuation methods did not work in Tokyo. American companies traded on a multiple of 21 times last year’s earnings, compared with 18 for Europe, 17 for Japan, and 14 for emerging markets. On a cyclically adjusted basis (averaging profits over ten years), the ratio of the American market to earnings is as high as it was in the bubble periods of the late 1920s and 1990s. It is worth remembering that those corporate profits are still very high, relative to GDP, by historical standards.
Perhaps all these things can be justified. America may have better prospects for economic growth than the rest of the developed world, not least because of its favorable demography. Its technology giants may be less vulnerable to competition than the Japanese multinationals of the late 1980s because they benefit from “network effects”, or natural monopolies. Also, profits may have shifted to a higher level in a world where trade unions are weak, the cost of capital is low, and business is very mobile.
Nevertheless, investing in one country only is an implicit concentrated bet, and is not the kind of lower-risk option that long-term investors are looking for.
For more on this we encourage you read the below Economist article.