Anatomy Of The Bear: Interview With Russell Napier
Russell Napier?s critically acclaimed Anatomy Of The Bear: Lessons From Wall Street?s Four Great Bottoms returned with a brand new edition earlier this year.
The new (fourth) edition of Anatomy Of The Bear: Lessons From Wall Street?s Four Great Bottoms includes an all-new extended preface from the author, which looks at the future direction of the US equity market in light of recent years and the book?s original groundbreaking research, and a brand new foreword from Merryn Somerset Webb.
Russell has worked in the investment business for 25 years and has been writing global macro strategy for institutional investors since 1995. Russell is founder and course director of the Practical History of Financial Markets at the Edinburgh Business School. Russell serves on the boards of two listed companies and is a member of the investment advisory committees of three fund management companies.
In 2014, he founded the Library of Mistakes, a business, and financial history library in Edinburgh. Russell has degrees in law from Queen?s University Belfast and Magdalene College, Cambridge, and is a Fellow of The CFA Society of the UK and an Honorary Professor at Heriot-Watt University.
Russell Napier was kind enough to answer some questions for ValueWalk about Anatomy Of The Bear, and the market in general, as part of ValueWalk?s Interview Series.
If you?re interested in finding out more about Anatomy Of The Bear, click here.
Interview with Russell Napier author of Anatomy Of The Bear
Rupert Hargreaves: First off, could you give our readers a brief summary of your now infamous first edition of your book, Anatomy Of The Bear: Lessons From Wall Street?s Four Great Bottoms?
Russell Napier: The book looks at the four great buying opportunities for US equities since 1900. I then read all the Wall Street Journal?s two months either side of the stock market bottom. The aim is to see whether the four bottoms had anything in common that would help us identify the next ?great bottom?.
RH: You?ve just published a new (fourth) edition of the book. What?s new this time around?
RN: The book was written to be a practical guide to investors. In each new edition I add a new preface that seeks to use the lessons from the analysis to make some forecasts for the future path of financial markets. The fourth edition has a preface that forecasts a major correction for equity markets. The last edition , published in April 2009, forecast a major rise in equity markets.
RH: In the book you look at four great market bottoms, 1921, 1932, 1949 and 1982 using as many as 70,000 articles from the Wall Street Journal written during these periods to get a sense of where the market is going. Without giving too much away, does there tend to one be a clearly defined feature that marks the bottom of the market?
RN: Yes the appearance of or the real risk of deflation marks the big bear market bottoms. Deflation has always been associated with falling corporate cash flows and this can threaten the very existence of equity given that it questions whether the company can meet its liabilities. A material rise in the risk of debt default raises the issue of whether corporate equity is worth anything!
RH: Studying how investors reacted in 1921, 1932, 1949 and 1982 is all very well, but since the last crisis, it?s clear that the structure of the market has changed significantly. Do you think these changes make it difficult to compare the bull/bear markets of today to those of 20 years ago, or even ten years ago?
RN: I think the real advantage of studying history is that we see many things in the current market that have happened before. While QE on the recent scale may be a genuinely new phenomenon intervention by governments and central banks to determine market prices is not new. Crucially history helps us understand the mechanisms through which money and credit are created and how they influence asset prices. So even when a new policy comes along we are well placed to judge how that might, or might not, work to influence the mechanism we study when we study financial history.
RH: One such change is the dramatic increase in popularity of ETFs, which have been called toxic instruments by some. Do you think the rise of the ETF and their instability will exacerbate market swings?
RN: The ETF is a form of auto-pilot for capital. It has a very very negative long-term impact as it exacerbates the so-called agency problem in which management and ownership are divorced from each other. Almost all the problems in the modern capitalist system stem from this agency problem. By creating a large owner of companies with no stewardship role over that capital we have created an even worse post-capitalist system of capitalism without capitalists. Anything that further dissociates management?s decisions from those taken by an owner are dangerous for the company and dangerous for society.
RH: In previous editions of the book, you talk about government bond prices, and how they can be used to identify market trends. Following the easy money policies of the Federal Reserve, do you think this is still a reliable indicator for investors?
RN: We have lived in periods of distorted government bond prices in the past. Post WWII the price of government debt was initially directly controlled by central banks and then indirectly controlled by governments through various forms of regulations known collectively as financial repression. Even in such periods there was a vestige of market pricing and this did provide important information for investors. So the importance of market determined interest rates as a signal declines in such eras but it is not eradicated.
RH: After a rocky end to 2015, 2016 is already shaping up to be a bad year for debt/equity and commodity prices around the world. Do you see any signs that this could be the beginning of a bear market?
RN: There are many indications that this could be the start of a bear market. Inflation is very low and the oil price decline of the past few months seems set to reduce it even further. A key conclusion of my book is that deflation is associated with falling corporate cash flows and this is very bad for corporate valuations. Of course, such declines in cash flows can produce defaults and a credit crisis. The collapse in the cash flows of commodity producing companies and some countries also reliant on commodity exports is already raising the real prospect of credit defaults in selected emerging markets. Such defaults will have a more limited impact on the credit system than the defaults from the huge US mortgage market post 2007 but they will come at a time when interest rates are very low. Investors are likely to doubt the efficacy of monetary policy if the next credit crisis comes at a time when interest rates are already low and central bank balance sheets already very large. There can be a direct negative impact on the developed world as the US$34trn global mutual fund business holds many assets that are insufficiently liquid to fund major redemptions from such funds. The closure of some of these funds, particularly those that invest in debt securities, can bring negative credit impacts to the developed world and particularly to the doors of savers.
RH: After nearly ten years of easy money policies and relatively calm markets, do you think investors are now ill-prepared for the risks ahead?
RN: Investors are ill-prepared because a notion has grown up that bad news is good news and also that good news is good news. Bad news brings more monetary largesse, which the consensus believes pushes equity prices higher, while good news pushes corporate earnings and valuations higher. Clearly no such world can really exist or there would be no downside for equities. It is because a belief in the central bank safety net for equity investors has become so prevalent that investors are ill-prepared for what happens when, despite almost ten years of monetary largesse, we get deflation and a credit crisis anyway.
RH: You must have built up quite a broad understanding of bear markets while researching the book. So, if you had to give just one piece of advice to a novice investor, to help them prepare for the next great bear market, what would it be?
RN: Invest your funds with a multi-asset fund manager and not an equity fund manager. Finding when equities represent good or bad value relative to other asset classes is very very difficult and best left to a professional manager. An equity fund manager is simply not mandated to provide that advice so you need to find a multi-asset fund manager who does.