Those of you who share a penchant for amateurish movies of yesteryear might recognize this title as a 1964 “monster-musical” that finally received a well-deserved lampooning on Mystery Science Theater 3000. It perhaps is not a surprise for us to be considering zombies, given how popular they’ve become lately, with World War Z, The Walking Dead, The Last of Us, each earning financial success and critical accolades.
As entertainment, I’m glad zombies are fictional and can be safely put aside once I’d turned off my television screen. I had hoped “zombies” as a theme wouldn’t be something I’d need to fear during work hours, but, sadly, that doesn’t seem to be the case. Zombies are everywhere and they may be growing scarier.
Let me back up and explain. The past quarter of market performance has been not been dominated by fundamental data – the specific earnings, revenue, business plan, and unique story of every company’s operations. Rather, the past quarter of the market performance has been dominated by macroeconomic factors that affect every company on a broad scale.
Specifically, there are two macroeconomic stories in the past quarter. First, the Federal Reserve comments on “tapering” of quantitative easing sent a shockwave through the market and our previous blog post – A Sea Change in Fixed Income – addressed the potential structural change to the US Bond market direction given the Federal Reserve’s change in tone. Second, the Bank of Japan has been rolling out its own monetary and fiscal stimulus program – essentially trying to out-do the Federal Reserve’s and Congress’s actions that were designed to spur the economy out of the 2008 tailspin. There are predictable effects to monetary easing; for example, as home currency gets weaker, exporters get stronger. This relative weakening of the currency and significant growth investment has translated to an incredible boom in Japanese equities, and skyrocketing interest from global investors.
The reason for these actions is clear: since the early 1990s, Japan’s economy has been stagnant and unable to grow. It is true the asset bubble in Japanese equities in the late 1980s had stretched beyond reasonable valuations and some market correction was due. However, falling stock prices are a mere symptom of the problem. The cause for the 20 year stagnation are complex, but can be fairly summarized this way: Japanese corporate culture strongly values stability over change. There are absolutely advantages to a stable, and unified corporate vision. The Japanese growth story was the envied through much of the 1980s for good reason. However, there are notable disadvantages as well. In practical terms, Japanese employees can presume to have lifetime employment, but hiring new employees and replacing them with better candidates is prohibitively difficult. The emphasis on stability means companies which should be go bankrupt are left to hobble along on government bailouts and become “zombie” companies, with a debt overhang too high to overcome. There are fewer incentive for entrepreneurship, creative destruction, or basic restructuring. The incentives favor passivity. Wide scale problems that require change, like the Japanese demographic and retirement crisis, are ignored in favor of maintaining the status quo.
So, perhaps the monetary policies of the Bank of Japan may be necessary for a growth-centric policy, but our fear is that the underlying corporate culture has not sufficiently changed to take advantage of any momentum earned from the reset in government policy. Furthermore, changes in currency strength often are a “zero-sum” game with winners and losers. The advantages for Japan exporters have largely come at the expense of their trading partners. As Japanese exports get cheaper, other countries feel an incentive to lower their own currency strength to compensate: a currency war. Thus, a financial contagions can spread and ultimately destabilize all world markets. So you see, trying to deal with zombies can indeed cause worldwide destabilization and conflict.