CLSA's Russell Napier - "QE 2 Fails - Sell US Equities - Await The Fed's Plan C On The Sidelines"

Tyler Durden's picture

In his latest Market Outlook, CLSA's Russell Napier, who has long been one of the better big picture strategists, comes to the same conclusion as we did when we penned from last Friday "$440 Billion Drop In Shadow And Conventional Banking System Liabilities In Q4 Gives Bernanke Carte Blanche For QE3" namely that the contraction in broad money aggregates (shadow banking in Zero Hedge's case, M3 in the case of Napier), opens the door wide for Bernanke to usher QE3. "recent data imply that the US reflation is in trouble. QEII has boosted reserves but banks continue to reduce credit, while broad money has contracted. There is material downside risk to equity valuations." In other words - "Sell equities as the market wonders whether there will be a QE3 and in what shape it will come. Napier's conclusion - "Whether equities will fall further depends on how flexible and successful the Fed’s next monetary package will be. Given the risk, investors are better off watching from the sidelines." This should not come as a surprise to Zero Hedge readers: we have been claiming since January that the market is due for a major correction in the end of March, early April in time to set the stage for the political wrangling that will inevitably accompany more monetary injections. That recent geopolitical events have forced some to coin the term "Glow in the Dark Swan" only makes the Fed's job that much easier...

Napier's key points:

  • Fed needs to get bank credit growing to get money growing
    • Broad money has contracted since the launch of QEII in November 2010 and this
      suggests that rising growth and inflation are not likely.
    • QEII is boosting unused bank reserves, but banks continue to shrink credit and it is having no direct positive economic impact beyond depressing Treasury yields.
    • Equity-market valuations are close to bubble levels and need the prospect of higher inflation and negative real rates to continue higher: but M3 is contracting.
  • Supply and demand challenges to reflating the USA
    • The largest US banks plan no credit growth, yet the Fed relies on this expansion; otherwise its boost to bank reserves will fail to increase the money stock.
    • Regulatory change, while necessary, threatens long-term stagnation in bank credit and money.
    • Corporate-loan demand is back, but the credit markets get most of that business.
    • The pace of household-sector degearing is surprisingly moderate, but there is no sign of a rebound in consumer demand for loans.
  • Private-sector credit demand weak outside corporate sector
    • Corporations are borrowing, but not through the banks.
    • Banks will accelerate security purchases, but this is unlikely to produce credit growth given the contraction in loans and leases.
    • Velocity has returned to its cyclical peak, but could surprise on the upside.
  • A risk to reflation would send equities sharply lower
    • The failure of QEII will undermine investor faith in a monetary solution.
    • With equities near bubble valuations, based on cyclically adjusted PE, a failure to reflate risks major downside.
      The Fed will try again with a new package, but investors would do best by waiting to see how it plays out.

Full Napier report:

Napier QE2 Failure