Once an economic powerhouse, Japan has struggled to regain its footing after the spectacular crash of its stock market in the 1990s. The Nikkei 225, Japan’s leading stock market index, soared to an all-time high of 38,916 in December 1989 before plunging to 14,309 by 2008, losing over 60% of its value (source: Bloomberg).
Unlike stock markets in the US and elsewhere that eventually recovered from crashes, the Nikkei has stagnated for decades. It remains well below its peak over 30 years later.
Why has the Japanese stock market never bounced back? This article explores the factors behind Japan’s ‘lost decades’ and stalled recovery.
Table of Contents
- The Asset Price Bubble That Burst
- Demographic Decline
- The Lost Decades
- Ultra-Loose Monetary Policy
- Risk-Averse Culture
- Zombie Companies and Poor Governance
- Psychological Scars from the Crash
- Limited Foreign Participation
- Looking Ahead
The Asset Price Bubble That Burst
In the late 1980s, Japan’s economy was flying high. Rapid growth in the prior decades led to huge asset price bubbles in real estate and stocks.
Excess liquidity, speculation and easy credit fueled the bubbles. At one point, the total value of land in Tokyo exceeded that of all the land in America.
When the Bank of Japan finally tightened monetary policy in 1989 to curb inflation and speculation, it pricked the asset bubbles. Prices came crashing down (source: Wall Street Journal).
The Nikkei plunged as investors panicked. At its peak, the Nikkei’s price-earnings ratio exceeded 60, reflecting overvalued stocks. Compared to a more reasonable P/E ratio of 15 today, stocks were wildly overpriced.
Japan’s demographics have been a major drag on growth.
According to the World Bank, Japan’s population is shrinking and rapidly aging. The working-age population peaked in 1995 and has since declined around 10%. Today, 28% of Japanese are over 65.
With fewer workers to support retirees, the demographic shift has dampened consumer spending and growth. The aging crisis has also led households to save more for retirement rather than invest in stocks.
The Lost Decades
In the 1990s, Japan experienced an extended period of economic stagnation and deflation known as the ‘Lost Decades’.
Bad debt from the burst asset bubbles paralyzed the financial system (source: Council on Foreign Relations). Banks and companies were saddled with non-performing loans and assets from the bubble years.
Weak domestic consumption dragged on growth. Deflation exacerbated the problem, increasing consumers’ purchasing power and reducing corporate profits and investment.
The economy struggled to regain momentum, hampering any recovery in the stock market.
Ultra-Loose Monetary Policy
The Bank of Japan took interest rates down to zero by 1999. Then it launched quantitative easing (QE) and other unorthodox policies to inject liquidity and stimulate growth.
But years of ultra-loose monetary policy failed to reflate the economy. Critics argue it allowed unproductive zombie firms to stay afloat, propping up bad debt and delaying needed reforms (source: Brookings).
Low rates also reduced returns on savings. This encouraged risk aversion rather than investment in stocks.
Culturally, Japanese households have tended to favor safer assets like bonds and savings over stocks. Risk-aversion deepened after the traumatic market crash.
According to Goldman Sachs, cash and deposits make up over 50% of household assets compared to under 20% in the US. Stocks account for less than 10%, versus over 40% in America.
This conservative investment bias starves Japanese firms of needed equity finance. But efforts to change remain slow.
Zombie Companies and Poor Governance
Zombie firms kept alive by years of cheap credit have depressed productivity and returns.
Poor corporate governance and lackluster reforms have also held Japan back. Management has often prioritized market share over profitability and return on equity.
With cross-shareholdings, firms own stakes in each other. This blurring of lines reduces accountability and willingness to cut costs or workers.
Psychological Scars from the Crash
The 1990s crash left deep psychological scars on Japanese savers and investors, turning them off stocks.
Many lost lifetime savings in the bubble years. Shamed executives resigned or committed suicide when asset prices collapsed.
Fear of losses has since led households to favor safe assets over stocks. Restoring confidence after such a traumatic event remains an immense challenge.
Limited Foreign Participation
Foreign investor participation in Japan’s stock market is much lower than in other major economies.
For example, foreigners own about 30% of shares on the Tokyo Stock Exchange versus 60–70% in the UK and US. Language and cultural barriers likely discourage foreign investment.
With limited external capital flows, the Nikkei lacks a key catalyst that could help push share prices higher.
While risks remain, recent political and economic reforms have raised hopes that Japan may finally be turning a corner.
The stock market has trended up since 2012 as monetary easing gains traction. But an aging crisis, massive debt, and external headwinds continue to pose challenges.
For Japan’s stock market and economy to make a full comeback, policymakers must double down on ‘Abenomics’ reforms: fiscal stimulus, monetary easing, and structural changes aimed at boosting competitiveness and long-run growth according to the Harvard Business Review.
Sustained political commitment and stock market liberalization could also draw in foreign investors with fresh capital. This would provide a vital spark reigniting Japan’s dormant economy and equity markets.
After decades of malaise, Japan has a massive challenge ahead to recapture its former glory. But with the right policies and reforms, the sun may yet rise again on Japan’s economy and stock markets.
Frequently Asked Questions
Q: What was the peak level of the Nikkei 225 before it crashed?
A: The Nikkei 225 reached an all-time high of 38,916 in December 1989 before crashing over 60% within the next three years.
Q: How did the Bank of Japan’s policies after the crash affect the economy and market?
A: The BOJ slashed rates to zero and implemented massive quantitative easing, but this cheap credit failed to ignite growth and allowed unproductive zombie firms to linger.
Q: What are some key differences between household investment behavior in Japan versus the US?
A: Japanese households favor safe assets like cash and bonds over stocks. Stocks make up <10% of assets versus over 40% for US households.
Q: How have demographics and aging affected the Japanese economy and market?
A: The shrinking working population has reduced growth and consumer spending. With more retirees, households have increased savings over investments.
Q: What reforms are needed to revitalize Japan’s economy and stock market?
A: Experts suggest further “Abenomics” reforms, sustained political commitment, measures to boost competitiveness, and increased foreign participation in equities.