Is a Japan-Style "Lost Decade" Ahead for the US?

The laborious pace of the US recovery has inevitably fostered comparisons with Japan. But we find several reasons why a protracted slump like Japan’s is unlikely, as my colleague Gerry Paul argues below.

Three Reasons Why the US Is Likely to Escape Japan's Fate

After five years of tepid growth, investors can be forgiven for wondering if the US is headed for a decades-long slump like Japan’s. The US, like Japan before it, is suffering from the repercussions of a massive real-estate, stock-market and banking-system collapse. But there are three reasons why the US economy and stock market are likely to escape Japan’s fate. 

The first is faster postcrisis deleveraging. Purging the enormous debt amassed during the global credit bubble is the biggest challenge facing the US (and most developed countries). Though daunting, the US debt problem is much smaller than Japan’s, in part because asset prices were never as inflated. At the height of their respective bubbles, the ratio of equity and real estate values to disposable income in Japan was roughly double the ratio in the US, as shown in the display below. 

Further, in Japan, aggregate income was falling along with asset prices, while debt loads remained constant. In the US, aggregate income has grown as debt levels and service costs have declined, further easing the burden. 

A key factor behind the US’s deleveraging success has been its ability to sustain economic output. The US Federal Reserve slashed interest rates, which lowered borrowing costs and weakened the dollar, which in turn lifted exports. The early boost in federal-government spending—even as tax revenues plunged with the recession—helped offset cutbacks by businesses and households, and remains an economic support. 

The US also moved much more swiftly than Japan to deleverage its banking system. In Japan, the government propped up insolvent (so-called “zombie”) banks for over a decade. In the US, banks were forced to write off many of their toxic mortgage assets, particularly those held in securitized form; as a result, the banks had to recapitalize. 

Corporate debt was a huge problem in Japan, but Japanese companies did not move aggressively to restructure; “zombie” companies persisted in Japan too. US companies, less leveraged to begin with, improved their balance sheets and cut costs. Household debt, which had skyrocketed during the credit bubble in the US but was not a major issue in Japan, has fallen sharply since 2008, both as a percentage of disposable income and in absolute terms, largely due to defaults. It has even returned to its long-term trend.

 As a result, the US deleveraging has progressed much more rapidly, although it will take many more years to return to balance. While government debt has risen, we expect strengthening economic activity and rising tax revenues to ultimately help reduce government deficits. History shows that the faster a country deleverages after a financial crisis, the less overall damage to the economy and the better the prognosis for future growth. 

The second key difference between the US and Japan is lower deflation risk. Deflation is a destructive force. Once it takes root, as it has in Japan, it becomes self-reinforcing and extremely difficult to dislodge. It also makes it much harder to dig out from under excess debt. 

Applying lessons learned from Japan’s experience and the US Great Depression, the US Federal Reserve moved quickly and aggressively to combat deflationary pressures at the onset of the recession by injecting massive liquidity into the financial system via ultralow interest rates and quantitative easing. Though the Japanese ultimately followed the same path, they took more than a decade to get started, far too late to outrun expectations of deflation. 

Today, US inflation is expected to remain positive, but low. With nominal interest rates extremely low, real interest rates are negative. This situation is terrible for savers, but stimulates consumption and investment and helps banks to recapitalize, because they earn a spread on their higher-yielding investments. Ultimately, negative real interest returns should encourage investors to shift to more risky assets in order to improve returns. 

The third reason why the US is likely to escape Japan’s fate is better demographics. Japan’s shrinking workforce and longer life spans are causing significant structural imbalances: there are ever fewer workers to generate tax revenues to support growing retirement and healthcare programs. The ratio of workers to nonworkers is higher in the US than in Japan and should stay that way for decades to come, thanks to a higher birth rate and a more open immigration policy. While the rising cost of government healthcare programs remains an issue in the US, it is primarily the result of escalating medical costs. We believe that it remains solvable with a bit of political will. 

In sum, more aggressive government and corporate actions to deal with problems in the US are bearing fruit. Indeed, corporate profits have eclipsed precrisis levels, and the financial health of American corporations has never been better. 

For now, however, all investors can see are reasons for worry. They have responded by shortening their investment horizons and dumping equities in favor of safe-haven assets, such as US Treasuries and gold.

But this won’t always be the case. As current economic and financial imbalances resolve, we expect investors to regain their confidence to take more risk.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Sharon E. Fay, CFA

Head and Chief Investment Officer—Equities
Sharon E. Fay was named Head and Chief Investment Officer of Equities in July 2010. She is responsible for overseeing AB’s portfolio management and research activities relating to all equity investment portfolios. Previously, Fay served as CIO of Global Value Equities from 2003 to 2014. From 1999 to 2006, she was CIO of European and UK Value Equities, serving as co-CIO from 2003 to 2006 after being named CIO of Global Value Equities in 2003. From 1997 to 1999, Fay was CIO of Canadian Value Equities. Prior to that, she had been a senior portfolio manager of International Value Equities since 1995. Fay joined the firm in 1990 as a research analyst, subsequently launching Canadian Value, the firm’s first single-market service focused outside the US. She then went on to launch the company’s UK and European Equity services and build Bernstein’s London office, home of its first portfolio management and research team based outside the US. Fay holds a BA from Brown University and an MBA from Harvard Business School. She is a CFA charterholder. Location: New York

Joseph Gerard Paul

Chief Investment Officer—US Value Equities
Joseph Gerard Paul was appointed Chief Investment Officer for US Value Equities in 2009. He has also served as CIO of the Advanced Value Fund since 1999. Paul was previously CIO of Small & Mid-Cap Value (2002–2008) and co-CIO of Real Estate Investments (2004–2008). For two years he served as director of research of the Advanced Value Fund, a leveraged hedge fund whose genesis he was instrumental in. Paul joined the firm in 1987 as a research analyst covering the automotive industry, and was named to the Institutional Investor All-America Research Team every year from 1991 through 1996. Before joining the firm, he worked at General Motors in marketing and product planning. Paul holds a BS from the University of Arizona and an MS from the Massachusetts Institute of Technology’s Sloan School of Management. Location: New York

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