When the bear won't let go

Globe Investor Magazine, Feb. 21, 2008
Photograph Susumu Takahashi/Reuters/Corbis

After the Second World War, Tokyo's stock market didn't reopen until May 16, 1949. The new Nikkei 225 index, meant to be a bellwether like New York's Dow Jones Industrial Average, closed at 176.2 that day. The Dow was almost a mirror image, closing at 175.8.

The next three decades were hugely successful for both markets, but much more astonishingly so for Tokyo. On Dec. 29, 1989, the Nikkei closed at an all-time high of 38,915.9, versus just 2,753.2 for the Dow.

Almost every investor knows what's happened since. After a long and punishing decline, the Nikkei bottomed at 7,607 in 2003, and is still staggering at about 15,000. Japan's economy sank into a prolonged slump.

Could a similar bust happen in North America? Prem Watsa, the CEO of Toronto-based insurer Fairfax Financial Hold-ings Ltd., isn't taking any chances. One of Canada's savviest investors, he's keeping the bulk of Fairfax's investments in bonds and cash. Watsa visited Tokyo in the late 1980s, and he sees the investor psychology as disturbingly similar-the fervour for stocks and the faith that central bankers won't allow a crash. So how long could a North American bear market last? "I'd love to tell you if I did know," says Watsa. Jeremy Grantham, who oversees more than $150 billion (U.S.) as chairman of Boston-based GMO LLC, calls the 1999-to-2000 run-up the "greatest bubble in American history." It should have been followed by a brutal bear market, but the the Americans slashed taxes and lowered interest rates to less than 1%. "That combination would have gotten the dead to walk," says Grantham.

North American markets have had a taste of a bear market this year, but most investors have no memory of more pro-longed slumps. The Dow declined by 89% from 1929 to 1932, and didn't climb back until 1954. The Dow first closed above 1,000 in 1972, then sagged, and didn't push beyond 1,000 until 1982.

If past bubbles and busts are any guide, Grantham figures the more broadly based Standard & Poor's 500 Index, which surged above 1,500 last year, is headed back down to 1,000 by 2010. And it might stay there for a very long time. - John Daly