KEY POINTS:
Almost two years ago, in a column titled Bull in the sushi shop - but for how long?, I described the remarkable bull market that Japan had enjoyed over the previous almost three years, particularly in the more speculative Second Section. At the time the Nikkei had doubled and a transformation had taken place as to how the world viewed Japan as an investment.
At the depths of a more than decade long bear market in early 2003, when the market had fallen by 80 per cent, everyone knew what was wrong with Japan. Deflation, cronyism and a bankrupt banking system were some of the weaknesses.
With hindsight it is easy to see what a great buying opportunity that was. What was incredible is how quickly perceptions changed as the market began to rise, and by early 2006 Japan had once again become the world's favourite market with the Nikkei doubling and the Second Section having virtually quadrupled.
By 2006 it was clear that the long-term bear market that Japan had been mired in for so long was finally over and that a new long-term, possibly multi-decade bull market had finally begun. I likened this period in Japan to what had been seen in the US 20 years earlier. Then the US was emerging from a 16-year bear market and was in the early stages of a huge bull market that was set to run for 18 years.
Like Japan in this decade, it was the smaller capitalisation stocks that stole the show in the US in the early eighties, far outstripping the Dow and S&P 500.
Unfortunately very long-term bull markets never run in nice smooth gradually rising trends, and that was the warning I raised two years ago - long-term, or secular, bull markets are made up of shorter cyclical bull and bear markets.
Smaller cap shares in the US plunged by more than a quarter, but that fall did not mark the end of the bull market, just that it had gone ahead far too quickly. Generally when a long-term outcome, like the recovery in Japan, becomes obvious, while the view or story may well be absolutely right, it is almost certainly more than priced into the market.
These "obvious" outcomes are usually accompanied by rampant speculation. The longer-term rise in the US did eventually resume but the fall lasted more than a year.
Two years ago I was concerned over the steepening rise that was occurring in the Nikkei and the Second Section amid a consensus that the Japanese recovery was obvious.
Two years later it is interesting to see what has happened in Japan. It has certainly slipped off most international investors' radar screens as other regions and markets have, until very recently, offered far greater returns and more excitement.
Over the past two years the Tokyo Second Section has fallen in half and the Nikkei is down about 25 per cent. This is what cyclical bear markets, even within longer-term secular bull markets, are like. Influential economist Ben Graham famously described markets over the long term as being like a weighing machine; they weigh up all the fundamentals such as earnings and dividends and set the price.
However, over the shorter term Graham described markets as being more like a voting machine that is driven by investors' collective enthusiasm or fear. This is why indicators such as price/earnings multiples can expand and contract so enormously and why cyclical bull and bear markets occur within secular bull and bear markets.
Simplistically the best selling opportunities occur when the consensus view of the future is bright, and the best buying opportunities occur after markets have fallen and expectations are low. Unfortunately determining emotional extremes is not particularly scientific, but successful investing has always been more of an art than a science.
Global sharemarkets are currently in a state of extreme turmoil. Given the falls that have been suffered over the last few weeks there is an abundance of advice both locally and internationally that great buying opportunities abound and valuations that were formerly stretched are now attractive.
This may well be true for traders; however, valuation is only a really useful timing tool over the very long term and it is also the case that the length and depth of cyclical bear markets is usually related to the preceding cyclical bull market. This can clearly be seen in the accompanying chart of the two Japanese indices.
In reviewing world markets, in the wake of this recent turmoil, it is clear that many are closely correlated, but it is also clear that for many markets these current cyclical bear markets are only a matter of weeks, or a few months, old, after bull markets that had lasted several years.
While trading opportunities may abound, it is likely that the best investment opportunities, for those with time frames of a few years rather than a few months, will be found in those markets that have come closer to completing a cyclical bear market.
The long-term bull may have left the sushi shop in February 2006, but it was never for good and it may be about to return.
* Kevin Armstrong is chief investment officer for ANZ and the National Bank.
