Preface

"Noise"

When we think of how the securities industry operates, perhaps the first word that comes to mind is "efficiency." The industry of elites, where bright minds and ample experiences go to war against one another in order to attain maximum profits and unimaginable wealth, may be the image conveyed by movies such as Wall Street.

In reality, however, transfer of knowledge and wisdom has not been executed very efficiently or smoothly in the securities industry. Some may point to a mountain of research papers written on a vast variety of subjects and say this is not so, while others may argue that modern technology has allowed us to amass a level of information unprecedented in quantity and quality. Indeed, bookshelves are filled with thousands of titles written on the subject of the securities market, stocks and bonds, and other financial instruments.

If we are to define knowledge or wisdom to be valuable and useful information, however, I am not at all sure how much knowledge and wisdom are actually being accumulated over time and generationally passed down in the securities industry. I worked in the securities industry for roughly a quarter of a century, and during my tenure, I heard the same questions asked and saw the same mistakes repeated over and over again. I believe that these facts alone constitute good enough evidence of "poor" transfer of knowledge and wisdom in the industry.

Richard Bernstein, the founder and CEO and CIO of Richard Bernstein Advisors and former Chief Investment Strategist at Merrill Lynch, in his book titled Navigate the Noise: Investing in the New Age of Media and Hype, said, "Investors are showered with so much irrelevant information, or noise, that the truly relevant information gets quickly buried or overlooked as being too obvious to be important. Investors probably need a great deal less information than is available to make an informed investment decision. More important, they need less information than they think they need" (Wiley, 2001, p. xii).

I cannot agree more with Bernstein.

There are several reasons for the "poor" knowledge and wisdom transfer in the securities industry, in my view. First, the people who work in the industry are highly specialized and proprietary. In some sense, equity researchers, sales representatives, and traders are like professional baseball or football players. Although they share some traits, their skills and know-how are often unique and cannot be easily shared. In addition, since their accumulated knowledge is their proverbial bread and butter, they have little incentive to readily dispense it.

The second reason somewhat overlaps the first, but the very nature of the securities industry hinders the generational bridging of knowledge and wisdom. By this, I am alluding to the rather quick and abrupt turnover of employees. The securities industry is well known not only for its oversized paychecks but also for its propensity to restructure at will, as the market goes up and down. Employees are typically given little notice before receiving pink slips, and thus there is no time to pass down what they know to the next generation of employees (and even if they have the time, they may not do so for the reasons stated in the previous paragraph).

The third reason is twofold: information overload and the size of the paycheck itself. On a daily basis, as Mr. Bernstein puts it, "Investors are showered with so much irrelevant information, or noise." On the other hand, brokers are getting paid handsome salaries by simply disseminating the "noise." Why would brokers bother to judge what is important and what is not if they are getting paid by distributing noise? Needless to say, the responsibility also lies with investors. This is because if investors like noise, brokers are almost obliged to supply them with noise.

Fourth, on the surface, the ever-changing nature of the market makes it difficult to discern what is relevant or important. The market is a mirror of the economy and collective sentiment of the people who participate in it. As such, the market is a "living" thing and thus evolves constantly. On the surface, therefore, there is no universal or natural law that governs the market into eternity. I have intentionally emphasized the phrase "on the surface" here. Although there is probably no "eternal" law, there are myriad laws and patterns that govern the market at least for some extended period of time, in my view. It may be difficult to uncover these laws and patterns, but with some effort, it can be done.

The motivation for writing this book is to transfer what I learned about the Japanese equity market through years in the industry. I worked for BZW Tokyo from 1994 to 1997, Merrill Lynch Japan from 1998 to 2000, Teachers Retirement System of Texas from 2000 to 2003, and J.P. Morgan Japan from 2004 to 2017. Having worked in the capacity of equity derivatives strategist during most of these periods, I saw the market from both the top down and the bottom up.

I lived through the aftermath of the collapse of the 1980s colossal Japanese bubble and saw the spectacular rise of the Japanese equity market during the internet bubble. I experienced the 2005-2007 global credit bubble, the subsequent market crash of 2008-2009, and the effect on the stock market of the Fukushima nuclear accident induced by the Great East Japan Earthquake in 2011. The next big thing for Japan was "Abenomics," which effectively began at the end of 2012, and I am now privileged to witness what the Japanese equity market will do in light of Brexit in the UK and Donald Trump's presidency in the US.

What is written here stems from the accumulation of facts and ideas from all those periods. In this regard, this is a history book as well as a guidebook, although the focus is on the period since 2004, after I began working for J.P. Morgan Japan. Also, this book is not a typical "Equity 101" book. I will not tell you how to pick "good stocks" in general terms. In fact, I am not even sure if picking "good stocks" works all that well in Japan (Warren Buffett may disagree on this point).

While some of the subjects covered in the book may be of historical interest and value only, these were significant at the time and were surely not "noise." To understand these historical facts and the lessons learned from them should no doubt benefit future generations of investors. What I have tried to do is lay out a simple map of investing in Japanese equities, with a belief that the paths depicted on this map may indeed help attentive and shrewd investors pave their own paths to enormous wealth.

On business trips overseas, some investors told me that they would not invest in Japanese equities because of the nation's shrinking population and lack of structural reform. While over a very long period of time their views may prove wise, that is not how you make money in equities. In my view, the Japanese equity market, when timed correctly, offers the best money-making opportunities among any major developed markets. I hope, by reading this book, investors will be able to take advantage of these fantastic opportunities in the future.

History Repeats Itself

"The Japanese equity market, when timed correctly, offers the best money-making opportunities among any major markets" is the assertion made in the last section. Whether we trade equities or other assets, the basic rule is to "buy low and sell high." In this sense, the above assertion is not an earthshaking statement. The issue is to know the proper "timing" of the trade.

The reason the Japanese equity market "offers the best money-making opportunities" is that proper "timing" is relatively easy to identify. This is because the Japanese equity market, among major developed markets in the world, responds most sensitively to the global economic conditions, a tendency largely unbroken since the early 1990s.

Analysts knowing the stock market is similar to doctors knowing illnesses. The stock market is ever-changing, but what is underneath are human thoughts and behaviors, just as human blood and genes play a major role in identifying illnesses. And just as doctors refer to past cases to find remedies, we need to reflect on past incidents to respond to the elusive stock market.

This is the reason why I consider this book "a history book," because it is a book of case studies. The various indicators and indices that we may learn about in a textbook only come alive in the context of history. Whether macro indicators or seasonality, the reason we focus on them is because they have been useful over significant time. Otherwise, they are just "noise."

As long as the equity market follows the trail of corporate profits, it is a reflection of the economy. If we know which way the economy is headed, therefore, we should know which way the equity market is headed. And knowing historical patterns helps us predict the direction of the economy to a large extent.

The short-term fluctuations of the equity market are not necessarily due to the economy, however. What is needed in forecasting short-term moves is an understanding of the "time" or "current," as those are often caused by "events." The word "events" refers not only to policy decisions and natural disasters, but also to supply-demand imbalance, leading to...