How Mania Looked Like When Japan’s Nikkei 225 Reached Record Highs in 1989

In documenting financial and or economic crises over 200 years Harvard’s Carmen Reinhart and Ken Rogoff noted of a common psychological denominator: This time is different

The essence of the this-time-is-different syndrome is simple. It is rooted in the firmly held belief that financial crisis is something that happens to other people in other countries at other times; crises do not happen here and now to us. We are doing things better, we are smarter, we have learned from past mistakes. The old rules of valuation no longer apply. The current boom, unlike the many previous booms that preceded catastrophic collapses (even in our country), is built on sound fundamentals, structural reforms, technological innovation, and good policy. Or so the story goes …

“This time is different” circa 1989 as the Nikkei reached record highs.

From the Wall Street Journal Japan Real Time Blog (hat tip/chart from Zero Hedge) [bold mine]

After the Japanese stock market hit its all-time high on Dec. 29, 1989, analysts were still looking forward to another strong year for shares in 1990, despite some signs of danger.

The following is a Wall Street Journal article by Marcus W. Brauchli looking at the likely direction of the Japanese stock market following its record finish in 1989. The article was published Jan. 2, 1990.

Tokyo Stocks: Japan’s Believers Expect Surge in Stocks to Continue

TOKYO–Japan’s stock market spawns two kinds of investors: believers and skeptics. The believers are getting rich. The skeptics are getting sore.

For much of the past decade, the world’s biggest stock market has stumped the skeptics. Price-earnings ratios are astronomical. The differential between interest rates and corporate earnings is wide. Yet just when the market seems most top-heavy, it heads even higher.

The skeptics’ experience has been a litany of missed opportunities, and last year was no exception. The year-end rout many analysts feared in the bumpy days after the Oct. 13 slump turned into a record-stomping rally.

For believers, Japan’s stock market has been a money-spinner. Daiwa Securities Co. estimates that $100 invested in Japan’s market in 1981 would have generated capital gains worth nearly $650 today at prevailing exchange rates. The same amount invested on Wall Street would have earned $185 above the initial $100 invested.

As Tokyo’s market gallops into the Year of the Horse, the skeptics once again are wondering how long the market’s advance can continue. The believers are betting that it won’t slow anytime soon-and the consensus emerging from 1990 forecasts supports them. Even cautious predictions call for the Nikkei Index to end 1990 above the 45000-point level, climbing from its 1989 close of 38916. Other markets may perform better — and many did in 1989 — but few trend so chronically higher.

“We’re looking for another good year,” says Lawrence S. Praeger, chief strategist for Nikko Securities Co. Adds Christopher Russell, manager of research at Jardine Fleming Securities Co.: “The market looks well set.”

Behind such uniform optimism are many of the same fundamental struts that supported the 1989 market. The economy is expected to grow nearly 5% in the year ending March 30, and many economists already are predicting growth of more than 4% for the following year. Also, recurring corporate profits will grow about 11% in both years, according to forecasts by Nomura Research Institute 4307.TO -2.60%.

“The outlook is extremely good,” says Pelham Smithers, a research analyst at Shearson Lehman Hutton Inc.’s Tokyo office. Even the risk of a long-term decline, he notes, appears more limited than it was in 1989.

That’s mainly because some of the key negatives that sapped the market’s strength at times won’t recur. Last year, for instance, the market was hurt by a prolonged slowdown in market speculation and economic activity caused by the January death and February funeral of Emperor Hirohito. The market was then dragged lower at midyear by a series of political scandals. And external events took a toll, with the crackdown in Beijing weakening investor confidence in companies with ties to China.

Most of those market pitfalls were temporary. True, there is the chance of political trouble in February, when Prime Minister Toshiki Kaifu is expected to call a general election. But polls suggest his Liberal Democratic Party has been getting stronger, not weaker. Any gain by the party surely would aid market sentiment.

Yet there are a handful of danger signs that investors must guard against, analysts say. “The biggest negative for the market would be if the dollar picks up,” says Shearson’s Mr. Smithers. A weaker yen would increase the price of imports, fueling consumer-price inflation — which is expected to rise more than the government’s estimate of 2% this year in Japan. That might force the Bank of Japan to raise interest rates, which would tend to discourage stock market investment.

Moreover, some analysts worry that a weaker yen would exacerbate Japan’s trade surplus with the U.S. and might trigger protectionist measures by Washington. That kind of fight could hurt a lot of companies and send the market into a slide.

Any signs of these factors could be enough to send Japan’s institutional investors scurrying into cash. And because big investors, who tend to act in unison in Japan, are such major forces, that could set off a broad decline.

It’s that vulnerability that has caused some skeptics to miss out on some of the Tokyo market’s broad gains.

The skeptics fret that the price of Japanese stocks averages more than 60 times the issuing company’s per-share earnings. That price-earnings ratio is more than four times the U.S. average. And the differential between the yield available on short-term interest-bearing instruments, such as certificates of deposit, and the average earnings yield of Japanese stocks, is nearly 4% — high by historical standards.

These days, though, instead of analyzing why those numbers point to a collapse in share prices, more analysts are trying to explain how, with no wires apparently attached, stocks are still flying.

For instance, Paul H. Aron, vice chairman emeritus of Daiwa Securities America Inc., is the beacon of a movement that aims to show that differences in corporate accounting and business practices account for most of Japan’s high P-E ratios. If the ratios were adjusted for the differences, he says, Japan’s average P-E ratio would have been about 17.5 at the end of August, against a U.S. average of 13.5.

Another factor that boosts stocks is rotational buying. Instead of buying across all sectors, Japanese investors tend to look for special circumstances that will help one sector or another. Stocks that might benefit from a reduction in tensions with the East bloc or from economic cooperation with the Soviet Union rallied strongly in the last quarter of 1989 and are expected to continue advancing.

“In between the sector rallies, there could be some cooling down,” says Robert Jameson, an executive at Dresdner Bank’s Tokyo brokerage unit. “But a year is a long time in the Tokyo market, and it won’t stay cool for long.”

Overconfidence, bandwagon effect/appeal to majority, rationalization, vehement denial of risks, linear thinking (anchoring), and  voracious risk appetite—hallmarks of the “this time is different” mania.

Yet the battle between the skeptics and the believers highlight Dr. John Hussman’s Exit Rule for Bubbles: you have to decide whether to look like an idiot before the crash or an idiot after it. 

The bottom line: the obverse side of every mania is a crash.