Don't overlook a market when it's down

It pays to look at investing in areas that other investors are shunning, because all markets have their day eventually, and those currently in vogue may not last

In the short term, it often pays to go with conventional opinion when deciding where to invest your money. Markets are carried forward by the weight of current opinion and liquidity - where the most cash is being invested at the moment - is a powerful and often dominant force. In the longer term, however, which is where most of us really have our money, the effect is the other way round.

Now it usually pays to put your money in places which conventional opinion is currently shunning - and which by definition therefore tend to be out of favour and undervalued. Over time all markets have their day, and if you have the time to be patient the chances are that today's dogs will become tomorrow's stars.

Of course there is nothing original about such thoughts. Most of the great fortunes in investment have been made by contrarians of one sort or another (which is why incidentally the whole notion of regulated investment advice is something of a nonsense, since the one sure effect of regulation is to push advisers in the direction of conventional solutions, which guarantee that you miss out on the best current investment opportunities).

One of the classic examples in recent history was Sir John Templeton, who made a huge fortune by buying shares in Japan in the 1960s, when the country was known in the West only as a manufacturer of cheap and rather shoddy cars and consumer goods. He recalls how at the time you could buy companies such as Nissan and Toyota on a price/earnings multiple of four. Nobody else wanted to know about Japan in those days. The next thing you know the Tokyo market has embarked on one of the greatest bull runs of all time. By the end of the 1980s, it was the place where everyone who was anyone had to have their money. Every stockbroker and investment bankers worth his salt was opening an office in Japan.

Result: the market crashed and lots of people who only climbed on the bandwagon when it was everybody's choice lost a fortune. There could be no better example of the timeless truth that for the best results it often pays to buy markets that nobody else wants to know about, and avoid those which are suddenly all the talk of the town. Do such opportunities exist today? Of course they do, though by definition few people will be talking about them.

These thoughts were prompted by reading an interesting presentation by Bruce Johnstone, one of Fidelity's top fund managers, at a recent conference in London. He asked his audience to take a look at the chart I show on this page and compare the current valuations of two markets (which he did not name until he had finished). Which of the two markets looks the better bet for anyone interested in securing above average investment performance over time?

Is it country X, where shares have rarely if ever been so expensive relative to bonds and profit margins are near an all-time high? Or country Y, where they have never been so cheap in the past 30 years relative to bonds and profit margins are near an all-time low? Which of the two stock markets do you think is most likely to go up and which is most likely to go down - bearing in mind that market capitalisation in the first country has already risen five-fold in the past eight years, while that in the second has fallen even faster over the same period? Neither market, incidentally, is in an obscure country which you have never heard of.

Well, no doubt by now you have guessed the way this argument is going. On a balance of probabilities, the long-run odds must favour the second market achieving the better results. Which two countries are we talking about?

Well, the answer - as you may also have guessed - is that country X, the first country in the chart, is the US; and country Y, the second country, is Sir John Templeton's old friend, Japan. So much bad news is coming out of Asia at the moment that it is easy to lose sight of the longer- term perspective on market valuations.

None of this is to deny that there is a real and profound economic crisis developing in the Asian region. It will clearly be some time before the crisis is resolved. No expert that I have talked to has any real or clear idea how and when it will be resolved. The Japanese have already made several attempts to kick-start their economy, so far without success. But the question for long-term investors to resolve is not whether or not the crisis is for real - that is after all what has helped to create the buying opportunity - but whether or not you think that the Japanese economy will one day sort itself out and recover.

If you think that the answer to that question is yes, then it is certainly worth considering whether you might profit from having some of your equity funds invested in that region.

After all, as Mr Johnstone pointed out, the headlines that are coming out of Japan today are no worse - and in some ways still better - than those you were reading about the US economy back in 1982, which was the year when the great US bull market took off in earnest. To take just one or two examples, the number of mutual funds was down by 80 per cent, unemployment was at its highest since the Depression, and consumer confidence was at a record low.

Interest rates were still off the scale. And so on. Compare that with today, when 85 per cent of US investors are reported to expect shares to return 20 per cent a year for the next 10 years and unemployment has rarely, if ever, been lower.

I cannot tell you whether the Japanese market has yet reached the bottom of its current trading slump, or whether the American bull market has quite yet peaked. Nobody can call the turns with that amount of precision. But I would be astonished in 15 years to find that the disparity in valuation between the US and Tokyo markets was still as great as it is today.

Push me into an unregulated opinion, and I might also say I would not be surprised to find that the Tokyo market was more highly rated than Wall Street. What is not in doubt is that the markets will turn, just as surely as night follows day.