Nikkei and Policy Reflexivity
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If what we face is a modern deflationary bear market, then I think Japan’s Nikkei is an excellent illustration of how the markets respond to QE policy. From Sitka Pacific Capital Management’s March 2010 letter:
The chart of the Nikkei on the previous page is an example of a “modern” deflationary bear market; i.e., a
deflationary bear market which is influenced on the way down by episodes of central bank monetary
printing. The Nikkei did not go straight down like the US market did during the great depression, but the
end result was the same. The main difference is that it took 20 years to do it, instead of just 4 years.
In order to achieve positive gains in Japan’s market during that long deflationary bear market, it was
necessary to trade into the market when the odds were favorable for gains, and then trade out of the market
when the odds were unfavorable. It took discipline to not try and wring every point out of an advance,
because often the market took back late gains much quicker than they were made, as it did in Japan in 1993,
1996 and in 2000.
This trade-focused approach has also been the winning approach here in the US over the past 10 years, and it will
likely continue to be the winning approach until the end of this long-term valuation contraction.
So QE policy does nothing to counteract a bear market, it only serves to stretch it out. I hope the inflationists are prepared to be wed to their views for the long haul. In ten years or so, I’ll will be joining the inflationist party. I hope there is some beer left by then.