From "Creative Destruction" to Innovation: Here's how the U.S. steers clear from "Japanification"!

Wednesday: The Independent Investor

FROM THE DESK OF MILES EVERSON: Welcome to today’s “The Independent Investor!” We hope you’re having a great midweek. We’re excited to talk to you about an interesting investing insight. Every Wednesday, we publish basic investing tips to help you boost your finances and investment portfolios. In this article, let’s focus on a recent issue that states the U.S. is heading towards “Japanification.” Read on to know what my friend and colleague, Professor Joel Litman, says about this topic. CEO, MBO Partners Chairman of the Advisory Board, The I Institute

From "Creative Destruction" to Innovation: Here's how the U.S. steers clear from "Japanification"! During the peak of the COVID-19 pandemic, individuals and businesses alike were negatively affected by the deadly virus. A lot of people lost their jobs, and some even lost their loved ones. Meanwhile, some businesses saw declining sales and needed financial aid to recover. During that time, the U.S. government gave out loans to small and midsize businesses that were run well prior to the pandemic. Between the U.S. Treasury Department’s Paycheck Protection Program (PPP) and the Federal Reserve’s Main Street Lending Program, the U.S. government gave companies a bridge. The result? Those businesses that availed the loan were able to refinance their debt at low rates! [Refinance: The process of revising and replacing the terms of an existing credit agreement, usually as it relates to a loan or mortgage.] According to Professor Joel Litman, Chairman and CEO of Valens Research and Chief Investment Strategist of Altimetry Financial Research, these moves weren’t normal. It’s not often that the U.S. government gives out so much money so loosely to keep companies afloat. The thing is, as the world starts to move on from COVID-19, many folks worry that this refinancing free-for-all will come back to bite the U.S. economy. Companies that should have gone under have survived for far too long—meaning, there’s not enough room for new and improved businesses. Professor Litman says this was the same scenario that has held back Japan’s economy since the 1980s… and it’s a scary prospect for the U.S. to face. Is The U.S. Heading Towards “Japanification”? [Japanification: A term used by economists to refer to the stagnation that Japan’s economy has faced over the “Lost Decades,” and is typically applied in reference to the concern among economists that other developed countries will follow that same path.] In July 2023, Professor Litman flagged the “Japanification” of the U.S. economy as one of consulting firm McKinsey’s two most likely scenarios in the country’s future. He believes the U.S. has the strength and position to avoid this outcome, and the country’s financial system is working as it should. It’s just a matter of “creative destruction,” which, according to Professor Litman, means for the U.S. economy to keep growing, the country must let the laggards lose. This is the only way to push innovation forward. Since interest rates started rising in 2022, creative destruction has begun to show up. Companies that should have gone bankrupt… have gone bankrupt. In fact, in June 2023 alone, a dozen or so companies went belly-up. This includes ATM maker Diebold Nixdorf and aerospace supplier Incora. Defaults were also on the rise. In terms of bankruptcies, Professor Litman says 2023 had the worst start to a year since the end of the Great Recession. The U.S. even saw more bankruptcies than it did during the pandemic! [Default: This refers to a borrower’s failure to make required interest or principal repayments on a debt, whether that debt is a loan or a security.] The reason for these bankruptcies and defaults? These companies were just using pandemic-era government programs to delay the inevitable. However, they couldn’t keep it up forever. Credit-ratings agency Fitch was able to prove this. After studying 30 companies that delayed their maturities or took on more debt during or after the pandemic, the agency found that 24 of these businesses had either defaulted or undergone some other form of restructuring. So, what’s the key takeaway here? Failure is always on the horizon for such companies… it’s only a matter of time. According to Professor Litman, bankruptcies are vital to any good capitalist economy. Companies that can’t pay their debts will have to go under. This will then allow capital to be allocated to areas with more opportunity. Professor Litman adds this is one of the key ways in which the U.S. differs from 1980s Japan. The willingness to not “save sacred cows” has allowed the U.S.’ aggregate Uniform return on assets (ROA) to rise for most of the past 20 years. Overall, the U.S. economy generally rewards well-run companies and punishes those that aren’t… and for Professor Litman, this is what sets the country on a path away from “Japanification.” This is also the reason why he and his team are bullish on U.S. stocks, even though the country could be in a sideways market for a while. [Sideways Market: This refers to a period when an asset doesn’t show significant upward or downward price movement but continues to trade in its current price range.] Keep these investing insights in mind!     Hope you’ve found this week’s insights interesting and helpful. The prevalence of remote and hybrid work setups have led many companies to rethink their office leases. Learn more about the importance of looking at credit in next week’s article!