Russell Napier's Latest View On Equities, Credit, And The General Economy; Sees 30% Upside In Stocks
CLSA's Russell Napier is one of the more respected strategists out there. Which is why his latest outlook on various asset classes is required reading, even if we very much disagree with some of his "facts." In essence Napier is betting on a smooth inflation premise, which will result in a surge in stocks by 30%+ over the next 18 months, and a crash in bonds. As justification for the validity of his observations, Napier refers to CLSA's M3 proxy which he notes is starting to rise, and makes reference to such shadow economy indicators as ABS whose issuance he believes is picking up, indicating a return to a normally functioning credit market. Napier also cites the often misunderstood concept of capital on the sidelines, which for Russell means only one thing: "corporates are not using [cash] to repay debt so it will be used to the benefit of the economy or asset prices." So far this premise has been proven completely wrong, as corporations more than anything demonstrate a capital prudence in light of a regulatory environment which is very uncertain, and instead of exposing themselves to counterparty banking, companies are now their own banking centers. We don't see this trend changing any time soon, especially when one considers imminent changes to the tax code, which will make hoarding of cash even more difficult. Lastly, with gross profit margins (as Hussman pointed out) having just one way to go, and the result being a substantial drop in cash generation, companies will likely store as much cash as they can get their hands on. Nonetheless, Napier does bring up some useful observations, especially as pertain to rates. Full presentation inside.
One specific item that Napier is patently wrong on is his belief that the shadow banking system is renormalizing. A month ago we demonstrated that in Q1 the shadow banking system collapsed by a record $1.3 trillion.
Back then we said:
The decline in shadow banking liabilities (defined as
the total shares outstanding in money market mutual funds, the total
liabilities of GSEs, total pool securities in the GSE mortgage pool, the
total liabilities of ABS issuers, the total amount of securities loaned
by funding corporations, the total liabilities of Repo markets, and
total outstanding Open Market Paper: all of these can be found in the
Z.1) between December 2009 and March 2010 amounted to $1.33 trillion!
This was nowhere near even remotely offset by the $250 billion increase
in liabilities of Commercial Banks. The full detail of the collapse in
the shadow banking system is presented in the charts below.
And here are the visuals:
And the sequential change - this needs no further explanation:
Lastly, we completely disagree with the assumption that "corporate are cheap even with a double dip" - as Rosenberg has shown, a realistic estimation of EPS, coupled with a decline in GDP, would put 2011 S&P EPS in the 60-70 ballpark. The associated multiple for an economic contraction is about 11-13x, and lower, meaning that in a double dip, stocks have about 30% downside risk from here. Of course, all this assumes that the Fed will continue retaining control over capital markets. Should interest rates explode, it is game over for every asset class as that would be the dreaded gray swan.
So despite the acts of factual (c)omission, here are Napier's most recent thoughts: they serve as a good framework to see what equity bulls take for gospel, regardless of how many holes the argument ends up having.