Japan Nikkei All Time High Is NOT What It Seems - No AI Zone

With headlines screaming Japan's Nikkei 225 stock index hitting ALL TIME HIGHS, you might think this actually means something! The prior all time high was December 29, 1989, so basically the Japanese stock market went NOWHERE for 34 years!  The chart looks even worse! Using the 1989 year-end high as the start date and normalizing to 1000, with other world indexes added for good measure, this is what we get:

S&P 500 = U. S. S & P 500 STOCK INDEX

DAX = Germany DAX PERxFORMANCE-INDEX
HSI = China HANG SENG INDEX
CAC 40 = France CAC 40 INDEX
FTSE = U.K. FTSE 100 INDEX
NIK = Japan NIKKEI 225 INDEX

The numbers are no better:

While the Nikkei 225 has had a good year, up 27% , every prior rolling period it has underperformed the S&P. Ok, the 10 year rolling return, from 2014 to 2024, at 9.4% is close to the S&P's 10.3%, but over the long term the Nikkei is DOWN (all returns are continuously compounded). And Japan is not alone. Everywhere else in the world lags the U.S.. (Kudos to France for a competitive 3 year cagr!)

WHY IS THIS? Some answers seem obvious. Brexit kneecaps the U.K AND the E.U! And China going rogue doesn't help the Hang Seng. Germany is steady but consistently behind the United States. So what's going on here?

I think it's Econ 101 and Ricardo's competitive advantage, a touch of Adam Smith plus the rise of equality in America (admittedly, now under fire). 

The answer is labor and capital and culture. The U.S. has more mobility of capital AND labor than any nation in the world. We have fewer capital restrictions than almost any other economy. We also have the greatest mobility of labor in the world. 

While some don't want to acknowledge it, the U.S. has open borders - and this is a good thing! Immigrants counter the crushing effects of ageing population, fuel the demand for labor and propel American growth. U.S. has the weakest caste system in the world (read DEI -diversity, equality and inclusion) which contributes to the mobility and American prosperity. 

To the extent isolation, fascism and bigotry are rising, these advantages are at risk. No society is perfect but the question was not perfection, it was why does America outperform?

SPY All time Highs -What's a Long-Term Investor to Do? NO AI WAS USED IN THIS POST!

On its 1/19/2024 $482.43 close, the SPY has finally closed at a new ALL TIME HIGH. It has taken 746 trading days or 2 years and half a month for the market to get back to square 1!

SPY = SPDR S&P 500 Exchange Traded Fund

Source: Yahoo finance

Looking at the above SPY chart since inception, note that for much of its life SPY was AT or NEAR its all time highs! Almost 40% (3038/7800) of all trading days were NOT in major drawdowns. All time highs are not that special for SPY (or DIA or QQQ, for that matter!). What is of most interest to buy and hold investors, is not the highs but the lows -- the frequency, timing and duration of drawdowns. 

Source: Yahoo finance

For instance, the SPY was down almost 60% in March 2009! It fell almost 50% in 2002 and touched minus 25% in its most recent 2022 drawdown! Below is the list of seven major SPY drawdowns since inception:

Source: Yahoo finance

With the market reaching all time highs in the last week, WHAT'S AN INVESTOR TO DO?

One option is to do nothing! A very Bogle-like answer. Admittedly 7 years may be a long time to wait for recovery but thankfully, a 7 year wait has only happened twice in SPY's 30-year history. The S&P 500 index had only two longer waits in it's 97 year history!

Source: Yahoo finance

The 25 year drawdown of the Great Depression was a little much. And the Go Go Nifty Fifty collapse was right in line with SPY's drawdowns. The solace here, if there is any, is that nobody did any better than the indexes anyway. Still true today.

As for another plan of action, what about insurance?

The most basic kind of insurance is what option* traders call the "Married Put". This is when the stock and its at-the-money put are held in the same account.  Puts give you the right to sell your stock any time before expiration at the strike price. So, if the stock falls below the strike, you can always sell it at the higher strike. 

Let's look at the cost and returns of holding SPY WITHOUT versus WITH insurance. 

Source: Schwab thinkorswim

The above table is a record of being long the SPY and buying the one year put on the last trading day of the year. SPY puts began trading in 2005, so, this is a complete record. 

For example, on the last day of 2005, SPY closed at $123.51 and the nearest 12/15/2006 $125 put closed at $5.70. The premium cost 5% of SPY's price! So after a year, SPY closes 2006 at $141.62 for a gain of 13% and the put expires worthless! If you bought the insurance, your net gain would only be 8% (13% SPY - 5% Put). 2006 was not a good year for insurance. 

As you look down the table you will see that most years, the put would expire worthless and just drag down the SPY return. Of course, 2022 was different. One way to look at this is to compare stock insurance to any other insurance. The one year married put premiums averaged 8% since inception. Is it worth 8% of your house value to insure your house for a year? Or your car? Your car, maybe yes. Insurance on  a $10000 car may cost $800. 

In sum, insurance would cut the SPY annual returns by half to roughly the rate on Treasury bonds.  If you really think we are on the heels of a great depression, with two world wars in twenty years, maybe so. In today's world, maybe not so. 

Why SPY? Is SPY the market? No and yes. SPY, which tracks the S&P 500 index-roughtly 80% of the market, is the world's largest, most liquid, least expensive and lowest tracking error exchange traded fund. 

*Options are a complex subject with ton's of online resources that may or may not be worth study. Why not? There's too much misinformation in many option claims and, historically, option mutual funds (arguably the richest and smartest option traders), sadly, underperform the S&P.