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  • 8/20/2019 Russell Napier Sept09

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    Russell Napier

    The Two Year Rally & Final Collapse

    Anatomy ofthe Bear

    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 2IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    Conclusions

    To reach record lows (1921, 1932, 1949, 1982)equities will have to fall 50% - not yet.

    Deflation produces record-low valuations but prolongeddeflation remains unlikely.

    Deposit insurance, Freddie & Fannie, Fiat money andthe lessons of history mean deflation is unlikely.

    A significant rally is likely and investors need to look atcorporate bonds, commodities (copper) and TIPs.

    The final leg of the equity bear market will be drivenby a bear market in treasuries.

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    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 3IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    How cheap are equities?

    Source: CLSA Asia-Pacific Markets

    0.0

    0.5

    1.0

    1.5

    2.0

    2.5

    1900 1909 1918 1927 1936 1945 1954 1963 1972 1981 1990 1999 2008

    Q ratio for US equities with S&P 500 at 800

    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 4IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    How cheap are equities?

    Source: CLSA Asia-Pacific Markets

    Cyclically adjusted PE with S&P 500 at 1000

    0

    5

    10

    15

    20

    25

    30

    35

    40

    45

    50

          1      8      8      1

          1      8      8      4

          1      8      8      7

          1      8      9      1

          1      8      9      4

          1      8      9      7

          1      9      0      1

          1      9      0      4

          1      9      0      7

          1      9      1      1

          1      9      1      4

          1      9      1      7

          1      9      2      1

          1      9      2      4

          1      9      2      7

          1      9      3      1

          1      9      3      4

          1      9      3      7

          1      9      4      1

          1      9      4      4

          1      9      4      7

          1      9      5      1

          1      9      5      4

          1      9      5      7

          1      9      6      1

          1      9      6      4

          1      9      6      7

          1      9      7      1

          1      9      7      4

          1      9      7      7

          1      9      8      1

          1      9      8      4

          1      9      8      7

          1      9      9      1

          1      9      9      4

          1      9      9      7

          2      0      0      1

          2      0      0      4

          2      0      0      7

          2      0      1      1

    (X)

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    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 5IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    Hindsight value

    Source: Smithers & Co., CLSA Asia-Pacific Markets

    0.0

    0.5

    1.0

    1.5

    2.0

    2.5

    3.0

    1900 1910 1920 1930 1940 1950 1960 1970

    Hindsight value over 1-40 year horizon

    Q versus average

    (x)

    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 6IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    Long bear markets are normal

    40

    50

    60

    70

    80

    90

    100

    110

    120

    1900 1902 1904 1906 1908 1910 1912 1914 1916 1918 1920

    (DJI)

    Dow Jones Industrial Index, 1900-1921

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    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 7IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    Long bear markets are normal

    90

    110

    130

    150

    170

    190

    210

    230

    250

    1936 1938 1940 1942 1944 1946 1948 1950

    (DJI)

    Dow Jones Industrial Index, 1936-1950

    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 8IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    Long bear markets are normal

    500

    600

    700

    800

    900

    1,000

    1,100

    1964 1966 1968 1970 1972 1974 1976 1978 1980 1982

    (DJI)

    Dow Jones Industrial Index, 1964-1982

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    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 9IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    History shows how deflation is one of the few times when

    bonds outperform equities.In periods when deflation has been probable, equities yieldmore than bonds.

    Deflation kills equity, as assets decline faster than liabilities.

    Deflation kills equity if cashflow declines, forcing debt defaultsby corporations and individuals.

    All the great bear-market bottoms coincide with the deathof deflation.

    Deflation drives low valuations

    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 10IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    Key inflation indicators - TIPs

    2003 2004 2005 2006 2007 20080.0

    0.5

    1.0

    1.5

    2.0

    2.5

    3.0 (%)

    2003 2004 2005 2006 2007 20080.0

    0.5

    1.0

    1.5

    2.0

    2.5

    3.0 (%)

    Yield on 10-year Treasury securities minus yield on 10-year TIPs

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    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 11IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    Key inflation indicators - BAA bonds

    Aug 1982Feb 1982

    Jun 1949Jan 1948

    Jul 1932May 1932

    Aug 1921Jun 1921Equities bottomCorporate-bonds bottom

    Timing of corporate-bondS and equity-market bottoms

    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 12IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    Key inflation indicators - BAA bonds 2008

    N D J F M A M J J A S O N D J F M A M J J A S O N80

    85

    90

    95

    100

    105

    110

    N D J F M A M J J A S O N D J F M A M J J A S O N80

    85

    90

    95

    100

    105

    110

    Lehman Brothers BAA Corporate Bond Index

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    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 13IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    High Yield US Corporate Bond ETF (Price)

    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 14IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    Key inflation indicators - Commodities

    3W Oct 20012W Oct 20022W Oct 2002

    2W Aug 19912W Oct 19903W Jan 1991

    1W Oct 19822W Aug 19823W Jul 1982

    1W April 19804W Mar 19803W Dec 1980

    1W Mar 19731W Dec 19734W Jan 1974

    CRB indexDJ IndustrialCopper

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    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 15IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    March Copper Futures

    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 16IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    Command economy & inflation

    1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 20080

    10

    20

    30

    40

    50

    60 (%)

    1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 20080

    10

    20

    30

    40

    50

    60 (%)

    US home mortgages owned or ensured by US government agencies

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    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 17IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

     ‘Let the slump liquidate itself. Liquidate labour, liquidate

    stocks, liquidate the farmers, liquidate real estate . . .It will purge the rottenness out of the system. High costsof living and high living will come down. People will workharder, live a more moral life. Values will be adjusted, andenterprising people will pick up the wrecks from lesscompetent people.’ 

    Words of the Secretary of the Treasury AndrewMellon, attributed to him by Herbert Hoover

    Inflation & the political dynamic

    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 18IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

     ‘Of course, the US government is not going to print moneyand distribute it willy-nilly (although as we will see later, thereare practical policies that approximate this behavior). Normally,money is injected into the economy through asset purchases bythe Federal Reserve. To stimulate aggregate spending whenshort-term interest rates have reached zero, the Fed mustexpand the scale of its asset purchases or, possibly, expand themenu of assets that it buys. Alternatively, the Fed could findother ways of injecting money into the system - for example, bymaking low-interest-rate loans to banks or cooperating with the

    fiscal authorities.’ 

    Ben Bernanke, November 2002

    Inflation & the political dynamic

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    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 19IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    TIPS indicated inflation

    1/6/09

    M J J A S O N D J F M A M J J A S O N D J F M A M

    0

    0.50

    1.00

    1.50

    2.00

    2.50

    3.00

    FRTCM10-USTCI10

    HIGH 2.57 3/7/08,LOW 0.04 20/11/08,LAST 1.60 29/5/09Source: DATASTREAM

    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 20IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    What stops the rally

    Inflation rising from 0% to 4% is good for equities.

    Deflation risk premium declines.

    Corporate share of GDP can rise.

    Central bank reaction is muted.

    Everything changes with inflation near 4%.

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    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 21IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    But beware inflation near 4%

    US inflation and Dow Jones Industrial Average, 1966-1978

    Source: Datastream

    66 67 68 69 70 71 72 73 74 75 76 77 780

    2

    4

    6

    8

    10

    12

    14

    550

    600

    650

    700

    750

    800

    850

    900

    950

    1,000

    1,050

    CPI (LHS)Dow Jones Industrials - Price Index

    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 22IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    But beware inflation near 4%

    US inflation and Dow Jones Industrial Average, 1985-1988

    Source: Datastream

    1985 1986 1987 19881.0

    1.5

    2.0

    2.5

    3.0

    3.5

    4.0

    4.5

    5.0

    1,000

    1,200

    1,400

    1,600

    1,800

    2,000

    2,200

    2,400

    2,600

    2,800

    CPI (LHS)Dow Jones Industrials - Price Index

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    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 23IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    But beware inflation near 4%

    US inflation and Dow Jones Industrial Average, 1989-2003

    Source: Datastream

    1998 1999 2000 2001 2002 20031.0

    1.5

    2.0

    2.5

    3.0

    3.5

    4.0('000)

    7.0

    7.5

    8.0

    8.5

    9.0

    9.5

    10.0

    10.5

    11.0

    11.5

    12.0

    CPI F(LHS)Dow Jones Industrials - Price Index

    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 24IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    But beware inflation near 4%

    US inflation and Dow Jones Industrial Average, 2002-2009

    Source: Datastream

    (1)

    2002 2003 2004 2005 2006 2007 2008 2009

    0

    1

    2

    3

    4

    5

    6 ('000)

    7

    8

    9

    10

    11

    12

    13

    14

    15

    CPI (LHS)Dow Jones Industrials - Price Index

    Source: DATASTREAM

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    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 25IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    US public debt % of GDP, 1792-2019

    0

    20

    40

    60

    80

    100

    120

    140

    1792 1807 1822 1837 1852 1867 1882 1897 1912 1927 1942 1957 1972 1987 2002 2017

    (%)

    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 26IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    S&P at 400 by 2014

    The CAPE and Q ratio lows of 1921, 1932, 1949 and1982 suggest the S&P will bottom at around 400.

    A loss of faith in US Treasuries and the dollar will drivethe final leg of the bear market.

    Treasury market likely to exceed US$12tn by 2011,when babyboom-medicare entitlement begins.

    Demand for Treasuries falls as emerging world goesfor consumption-driven growth.

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    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 27IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    S&P at 400 by 2014

    Share of total US Treasury market owned by foreigners

    (%)

    1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 20070

    10

    20

    30

    40

    50

    60 (%)

    1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 20070

    10

    20

    30

    40

    50

    60

    Source: Datastream

    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 28IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    S&P at 400 by 2014

    Growth in US population over the age of 62

    (m)

    5.92029-33

    8.12024-28

    9.62019-23

    8.72014-18

    3.02009-13

    4.22004-08

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    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 29IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.

    Conclusions

    US Treasuries could repeat their 83% price decline

    of 1946-81.

    The supply/demand imbalance for Treasuries can be metwith higher rates, higher savings and deflation.

    The supply/demand imbalance for Treasuries can be metwith Fed reaction to cap yields and produce inflation.

    The negative economic/political ramifications from foreignselling of Treasuries could prompt capital controls.

    ©2008 CLSA Asia-Pacific Markets (“CLSA”).

    Page 30IMPORTANT: The content of this report is subject to CLSA's Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA ComplianceGroup, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.