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Anatomy of the Bear Investing at the bottom Russell NapierMarch 17 th 2009
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Anatomy of the BearInvesting at the bottom
Russell Napier March 17th 2009
©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 may be obtained on request from CLSA Publications or CLSA Compliance Group, 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 prolonged deflation remains unlikely.
Deposit insurance, Freddie & Fannie, Fiat money and the lessons of history mean deflation is unlikely.
A significant rally is likely and investors need to look at corporate bonds, commodities (copper) and TIPs.
The final leg of the equity bear market will be driven by a bear market in treasuries.
©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 may be obtained on request from CLSA Publications or CLSA Compliance Group, 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 may be obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.
How cheap are equities?
Source: CLSA Asia-Pacific Markets
0
5
10
15
20
25
30
35
40
45
50
1881 1891 1902 1912 1923 1933 1944 1955 1965 1976 1986 1997 2008
(x)
Cyclically adjusted PE with S&P 500 at 800
©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 may be obtained on request from CLSA Publications or CLSA Compliance Group, 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 yield more than bonds.
Deflation kills equity, as assets decline faster than liabilities.
Deflation kills equity if cashflow declines, forcing debt defaults by corporations and individuals.
All the great bear-market bottoms coincide with the death of deflation.
Deflation drives low valuations
©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 may be obtained on request from CLSA Publications or CLSA Compliance Group, 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
©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 may be obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.
Key inflation indicators - BAA bonds
Corporate-bonds bottom Equities bottomJun 1921 Aug 1921May 1932 Jul 1932Jan 1948 Jun 1949Feb 1982 Aug 1982
Timing of corporate-bonds and equity-market bottoms
©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 may be obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.
Key inflation indicators - BAA bonds
J F M A M J J A S O N D J F M A M J J A S O N D J68
70
72
74
76
78
80
82
84
86
88
550
600
650
700
750
800
850
900Lehman US aggregate: Credit BAADow Jones Industrials - price index (RHS)
J F M A M J J A S O N D J F M A M J J A S O N D J68
70
72
74
76
78
80
82
84
86
88
550
600
650
700
750
800
850
900Lehman US aggregate: Credit BAADow Jones Industrials - price index (RHS)
Dow Jones Industrial Index and Lehman Brothers BAA Corporate Bond Index, 1974
©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 may be obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.
Key inflation indicators - BAA bonds
J F M A M J J A S O N D J F M A M J J A S O N D750
800
850
900
950
1,000
1,050
1,100
55
60
65
70
75
80
85Dow J ones Industrials - price indexLehman US aggregate: Credit BAA (RHS)
J F M A M J J A S O N D J F M A M J J A S O N D750
800
850
900
950
1,000
1,050
1,100
55
60
65
70
75
80
85Dow J ones Industrials - price indexLehman US aggregate: Credit BAA (RHS)
Dow Jones Industrial Index and Lehman Brothers BAA Corporate Bond Index, 1981
©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 may be obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.
Key inflation indicators - BAA bonds
J F M A M J J A S O N D J F M A M J J A S O N D1,600
1,800
2,000
2,200
2,400
2,600
2,800
90
92
94
96
98
100
102
104Dow J ones Industrials - price indexLehman US aggregate: Credit BAA (RHS)
J F M A M J J A S O N D J F M A M J J A S O N D1,600
1,800
2,000
2,200
2,400
2,600
2,800
90
92
94
96
98
100
102
104Dow J ones Industrials - price indexLehman US aggregate: Credit BAA (RHS)
Dow Jones Industrial Index and Lehman Brothers BAA Corporate Bond Index, 1987
©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 may be obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.
Key inflation indicators - BAA bonds
Dow Jones Industrials - price indexLehman US aggregate: Credit BAA (RHS)
J F M A M J J A S O N D J F M A M J J A S O N D J2,300
2,400
2,500
2,600
2,700
2,800
2,900
3,000
3,100
3,200
92
94
96
98
100
102
104
106Dow Jones Industrials - price indexLehman US aggregate: Credit BAA (RHS)
J F M A M J J A S O N D J F M A M J J A S O N D J2,300
2,400
2,500
2,600
2,700
2,800
2,900
3,000
3,100
3,200
92
94
96
98
100
102
104
106
Dow Jones Industrial Index and Lehman Brothers BAA Corporate Bond Index, 1990
©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 may be obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.
Key inflation indicators - BAA bonds
J F M A M J J A S O N D J F M A M J J A S O N D J
('000)
7.0
7.5
8.0
8.5
9.0
9.5
10.0
10.5
11.0
96
98
100
102
104
106
108
110
112
114
116
118Dow Jones Industrials - price indexLehman US aggregate: Credit BAA (RHS)
J F M A M J J A S O N D J F M A M J J A S O N D J
('000)
7.0
7.5
8.0
8.5
9.0
9.5
10.0
10.5
11.0
96
98
100
102
104
106
108
110
112
114
116
118Dow Jones Industrials - price indexLehman US aggregate: Credit BAA (RHS)
Dow Jones Industrial Index and Lehman Brothers BAA Corporate Bond Index 2002
©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 may be obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.
Moody’s BAA US Corporate Bond Yield
©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 may be obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.
Key inflation indicators - Commodities
Copper DJ Industrial CRB index4W Jan 1974 1W Dec 1973 1W Mar 19733W Dec 1980 4W Mar 1980 1W April 19803W Jul 1982 2W Aug 1982 1W Oct 19823W Jan 1991 2W Oct 1990 2W Aug 19912W Oct 2002 2W Oct 2002 3W Oct 2001
©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 may be obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.
May Copper Futures
Three Year US TIPS (Yield)
©2008 CLSA Asia-Pacific Markets (“CLSA”).
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Changing Deflationary Expectations
(%) Nov 08 Jan 091-year (5.3%) (0.5%)2-year (5.0%) (0.9%)3-year (3.6%) (0.5%)5-year (0.3%) 0.6%10-year 0.3% 1.0%
TIPS Indicated Deflation/Inflation
©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 may be obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.
Earnings-cycle propositions 1881-2009
Deflationary earnings contractions end after 23 months and normal contractions after 18 months.
The current 66% contraction is the third largest on record and earnings just above 1989 levels
Earnings normally contract a further 8-20% after the stockmarket bottoms.
Earnings contractions >57% only happened with nominal GDP contractions of 17% and 46%.
Market will bottom three to six months before the economy and nine months before earnings cycle bottoms.
©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 may be obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.
Conclusions on the rally
The limited deflation already factored in, is still unlikely.
The current 66% earnings contraction is already large and should end 2Q-3Q09 - market bottoms in 1Q-2Q.
Corporate-bond rally precedes equities.
TIPs price rise needs to accompany an equity rally.
Copper-price rally should accompany an equity rally.
©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 may be obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.
The S&P at 400 by 2014
The CAPE and Q ratio lows of 1921, 1932, 1949 and 1982 suggest the S&P will bottom at around 400.
A loss of faith in US Treasuries and the dollar will drive the 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 goes for consumption-driven growth.
©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 may be obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.
The 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 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 may be obtained on request from CLSA Publications or CLSA Compliance Group, 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 met with higher rates, higher savings and deflation.
The supply/demand imbalance for Treasuries can be met with Fed reaction to cap yields and produce inflation.
The negative economic/political ramifications from foreign selling of Treasuries could prompt capital controls.
©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 may be obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888.
