Historical Highs on Interest Rate Cuts
How a reduction in interest rates could compliment the bear case.
A year ago we posted “Fight the FED” in which we highlighted how, contrary to the popular perception at the time, rising interest rates historically produce rallies more often than crashes. Since this time rates have rose and markets have rose also. We’re now at 5.5%.
In this piece, we’re going to look at two other major index booms that are commonly accepted to be clear interest rate/central bank policy driven bubbles.
Nikkei up to 1900
Nasdaq up to 2000
The Miracle Economy
During the the run up in the stock market Japan was briefly viewed and studied as the most successful nation. It was dubbed “The Miracle Economy”. Later to be known as the “Bubble Economy”. It would all come to an end on the last day of 1989. Into 1989 Japan was the greatest market there was. From 1990, it got really bad.
The bubble economy in Japan during the 1980s was primarily fuelled by the monetary policies and low-interest rates implemented by the Bank of Japan (BoJ). Here's a breakdown of how BoJ rates and policies contributed to the bubble and its eventual burst:
Low Interest Rates:
- The BoJ pursued a policy of keeping interest rates exceptionally low during the early 1980s. This was intended to stimulate economic growth and investment. However, the unintended consequence was a surge in speculative activities, particularly in the real estate and stock markets.
Access to Cheap Capital:
- With interest rates at historic lows, businesses and investors had easy access to cheap capital. This led to a borrowing frenzy, especially among real estate developers and corporations. The abundance of cheap money fuelled excessive spending and investments in inflated assets.
Rapid Asset Price Inflation:
- The combination of easy credit and increased borrowing resulted in rapid inflation of asset prices, particularly in the real estate and stock markets. Land prices, in particular, skyrocketed to unsustainable levels, creating a speculative bubble.
Financial Deregulation:
- The Japanese government's deregulation of the financial sector allowed for greater flexibility and innovation in financial markets. However, it also facilitated riskier investment practices and contributed to the creation of financial products that amplified the speculative nature of the market.
Speculative Investments:
- Investors, both individual and institutional, engaged in speculative investments based on the belief that asset prices would continue to rise indefinitely. This herd mentality further inflated the bubble as more people entered the market, expecting quick and substantial returns.
Corporate Investments and Mergers:
- Corporations, fuelled by cheap capital, engaged in aggressive investments and mergers. The pursuit of expansion and diversification led to overvaluation of companies and contributed to the creation of Japan's massive corporate conglomerates, many of which later faced financial troubles.
Bubble Burst and Economic Consequences:
- In the early 1990s, the BoJ shifted its monetary policy, raising interest rates to curb inflation and cool down the overheated economy. This change, coupled with other factors, triggered the bursting of the economic bubble. Asset prices collapsed, leading to severe economic repercussions, including a prolonged period of deflation and economic stagnation known as the "Lost Decade."
Japan’s interest rate would eventually drop to under 0%. This did not benefit the stock market, which would remain in a net bear trend for over 10 years.
As I write this today in 2024, a new high is not been made. We have now finally returned substantially close to the 1990 high. 34 years. All at low interest rates.
Here’s where things get more interesting (For me, anyway). The popularly implied case and effect of interest rates and bear markets would have implied that the index would start to crash during the late 1980s. This is when the trend in rates turned and they got higher and higher late into the 1980s.
But as we just covered above, Japan pretty much owned the 80’s. Their success was studied all around the world. Japan was the place to be in the 80’s. It was literally the first days of the 1990’s the trend in Japanese equities would turn. During the late 1980’s, the market action was aggressively bullish.
The Nikkei was on fire during this rapid rising of interest rates. Which really does confuse basic logic when we know after the fact low rates drove the bubble. But that is what happened. The downtrend in rates stopped at the end of 1988 and it ended August of 1990. During this time, the index rose 200%.
In August of 1990 rates peaked. From here they’d to flat for a while and then begin their run to zero and beyond.
From June onwards the rates would downtrend but this did nothing for the index. It dropped 25% high to low in the month rates topped and down-trended with them.
Key Points
So the main points to note pertaining to interest rate moves and price action are;
Bottoming of rates was not top of market.
Very strong bull moves happened with rising rates.
Rates topped at 6%.
Rates and equities topped together.
Equities would decline on higher rates.
Lower rates later did not support the market.
The bubble pop from high to low was around 80%. It took 226 months (18 years!) before the market would start to uptrend again.
Irrational Exuberance
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