A mere 20 years ago, Japan's economy was the envy of the world. The Nikkei average had risen almost fourfold in the five years prior to 1989, and Japanese interests had snapped up such all-American entities as Rockefeller Center, Columbia Pictures, and the Pebble Beach Golf Course. No wonder many Americans believed that Japan was becoming the premier economy in the world and that America's best days were behind it.
There was a lot of compelling evidence to support such a view. According to some fascinating data provided by The New York Times, 73% of the value of the top 20 stocks in the world in 1989 was accounted for by Japanese companies compared with just 23% for the United States. And the top four companies worldwide by market value in 1989 were from Japan: Nippon Telegraph & Telephone, Industrial Bank of Japan, Sumitomo Bank, and Fuji Bank.
Things change
We know what happened next. The Japanese economic bubble burst, ushering in its so-called "lost decade" of the 1990s. By 1999, Japanese companies only accounted for 16% of the value of the top 20 companies worldwide compared with 72% for the United States. And of the top four companies in 1999, three were American: Microsoft
Fast forward eight years, and the world had changed yet again. Of the top 20 global stocks in 2007, only 38% of the value now came from American companies, and none of it came from Japanese stocks. Newly emergent China was now No. 1, accounting for 41% of the value. The top four global companies were now: ExxonMobil
So in just less than 20 years, Japan went from accounting for 73% of the value of the top 20 global stocks to zero. And China went from zero to 41% of the value. Clearly, one of the key characteristics of the global economy is change. Technologies change. Sectors come in and out of favor. And some national economies rise, while others fall. And some countries, like the United States, oscillate from irrational exuberance (remember Dow 36,000?) to irrational pessimism (remember the depths of the financial crisis?).
Lessons for investors
How can investors benefit from this information? I think the key lesson here is to diversify, diversify, diversify. It's a very simple lesson, but one worth meditating upon, over and over again.
First, one must diversify among companies. There was a time when it was inconceivable that anything detrimental could happen to impregnable blue chips like AIG
Second, one must diversify across countries. Tim Hanson, the advisor for Motley Fool Global Gains, recommends that aggressive investors should devote as much as 40% of their holdings to international stocks, and within that allocation, 75% should be in emerging markets with 25% in developed markets. It's not always easy to predict the fall of a Japan or the rise of a China. It's therefore best to invest in many different regions and countries. Will China be stronger or weaker 10 years from now? Will Petrochina and China Mobile be among the most valuable companies worldwide in 2020? The historical record suggests that it's unwise to go all in on such bets, regardless of your answers to those questions.
Events, dear boy, events
The British Prime Minister Harold Macmillan was once asked what was the most difficult thing about running the country, and he replied, "events, dear boy, events." I think that might be equally a good answer to the question of what is the most difficult thing about investing. Whether it's a bursting real-estate bubble or a leaking oil well, investors are always at the mercy of unpredictable events. Wise investors accept that fact, and then act accordingly.
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