selling america- a bears view
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8/2/2019 Selling America- A Bears View
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Selling America: The view from abear's chair Posted by Duff McDonald, Contributing Editor March 31, 2011 1:17 pm
From equities to Treasuries, the global macro strategist Russell Napier can't find much to be
hopeful about in the U.S. these days. He shares his views on the Fed, China, and how to fix
the banks with a Warren Buffett tax.
The outlook is bleak from this seat.
FORTUNE - Russell Napier wants to make a couple of things clear. First, says the global macro
strategist for brokerage house CLSA, he is not biased against the United States. It's just that thereare so many things working against it right now that the Irishman is, shall we say, a bit bearish on
America. And second, he's not a through-and-through pessimist about the direction in which the
global economy is headed. He sees a few bright spots. Just not many. Fortune spoke with him
Thursday morning to get a plateful of bad news and what spoonfuls of good he had to offer.
You have a sell on the U.S. equity market right now. Why?
This is the first time in two years I have been selling U.S. equities. It's for two reasons. The first is
valuation. And the second is that QE2 [quantitative easing] has failed, even though everybody I meet
thinks it succeeded.
On the valuation front, the cyclically adjusted price-earning ratio of the market is 23 times. From
1981 through 1995, we spent exactly 24 months above that level, and there were always poor long-
term returns if you bought. The same goes for 1995 through 2011. There's one exception, from 1995
to 2000, but make of that what you wish. You can debate the short-term prospects for the market
today, but the long-term ones don't look good. I said the market was cheap in September relative to
bonds. It isn't any more. The market is pricing in a lot of good things that we're not going to get.
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Which brings me to QE2. The Fed did succeed in changing some people's inflation expectations,
which has made them bullish on equities. They think people will stop hoarding deposits and start
spending them or investing. I have a query with the second part of that argument. Corporations are
borrowing in the US, but not through the banking system. The banking system is reliant on
households and small enterprises, and they aren't borrowing. In fact, bank lending continues to
decline. Banks are not expanding their balance sheets. The amount of money in America is not
going up. So even though the headlines scream that the Fed is printing money, the money supply
hasn't risen. They're creating fuel to create lots of money, but they haven't actually created it. The
stock market at these levels is looking for 3% real GDP growth and 1.5 to 2% inflation. I don't think
those forecasts are justified. The market is too excited.
What's the prognosis for US Treasuries? Do our foreign lenders ever give up on us and stop
lending?
I think so -- my guess is within five years tops -- but not for the reasons most people talk about, that
they've lost faith in the dollar or Treasuries. There are a number of countries out there holding their
exchange rates down by buying Treasuries. That's got to end, and for some it will be much sooner
than five years. It's creating excess inflation in their economies, because they're simply printing
money. Some are already panicking. Brazil and India have let their exchange rates rise. It's not that
they wake up and say, "We don't want more dollars." Rather, it's, "We better do something about
inflation."
So what happens to Treasuries? To the U.S. economy?
Yields on Treasuries will have to go up. Other countries don't have to be selling to cause an issue,
they just need to stop buying. And to find a new buyer, there's going to need to be a higher yield.
Foreign central banks bought about $800 billion in Treasuries last year. So consider that gap. Who's
going to step up? It's going to have to be a domestic buyer in the U.S. What price do you need on
Treasuries to lure people out of other asset classes? I think it will be significant. I think at least 100
basis points higher than now. And when that money shifts out of private sector assets -- the
corporate bond market or equity market -- into public sector assets, there will be a deflationary
adjustment.
If the switch happened tomorrow morning, the impact would be quite negative for economic growth.
Things would get tight pretty quickly for the private sector. Basically, an anti-inflation drive abroad is
deflationary for the U.S. It's the opposite of what Paul Volcker did. He attacked U.S. inflation and
bankrupted Mexico. When China finds a Volcker, it's America that goes bust.
So how can policymakers prepare for the possibility?
The obvious thing is to run smaller fiscal deficits -- not to borrow so much money. But that generally
doesn't work politically. There may need to be new rules to force people to hold more government
debt. Say, a 1.5% transaction tax on all financial instruments except government debt. But really, the
real answer is that you should borrow less money.
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What about bank capital requirements? There seems to be no end to this debate. Where do
you come out on it?
I think this is the wrong time to pare back capital requirements. You need to take advantage of the
opportunity for reform that a crisis brings. That's why the politicians need to keep going. But at the
same time banks need to expand credit. So I would have pushed the issue out a little further.
What's equally important, though, is the need to get the owners of banks to behave like they own
them. Institutions are turning over their bank shares every six months or so. They don't consider
themselves owners. I think we should get capital requirements up in the future but allow them to
grow at the moment, and in the meantime make sure shareholders own shares for longer and
engage with management. The job of policing management shouldn't be left to the government. It
should be the owners that do that. But we lost that. Again, maybe we need another tax to make
shareholders hang on longer. I would call it the Warren Buffett Tax.
How have events in Japan changed the short- or long-term global economic outlook?
In the equity world it's actually a positive. The Bank of Japan has been forced into a pro-growth and
pro-inflation policy. It would be treasonous not to do so. That means more money, more growth,
more inflation. That's good for equity markets.
That's quite a price to pay for a bullish equities signal. What other positive signs do you see?
The biggest thing in the world today is rising Chinese wages. Anyone who still has a manufacturing
sector -- not Detroit but Osaka -- gets a boost from rising Chinese wages. We're now seeing the
reindustrialization of some parts of the U.S. and the United Kingdom. Japan was going to benefit
from this rapid rise in Chinese wages and will still do so.
Since the end of Bretton Woods, we've had this dream of rebalancing global growth. I think it'shappening quicker than we think through this rise in Chinese wages.
So while I may be bearish from the top down, when you're talking bottom-up, there are wonderful
opportunities for people who can pinpoint those benefiting from the reversal.