CLSA PPT Template
25
Equity Valuation Inflation, deflation and mean reversion Russell Napier Strategist
Transcript of CLSA PPT Template
Equity Valuation Inflation, deflation and mean reversion
Russell Napier Strategist
Page 2
Conclusions
Key to mean reversion of CAPE- changing inflationary expectations
CAPE and Q drive capital creation and are reflexive
Technology is key but it is never as positive for non-inflationary growth as it seems
Deflation or inflation rising through 4% will reduce valuations
Equities can adjust more rapidly than bonds
Deflation comes next and sharply lower equity prices
Page 3
The mean reversion of CAPE
468
10121416182022242628303234363840424446
CAPE
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-1.2
-1
-0.8
-0.6
-0.4
-0.2
0
0.2
0.4
0.6
0.8
1
1.2
-1.2
-1
-0.8
-0.6
-0.4
-0.2
0
0.2
0.4
0.6
0.8
1
1.2
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
qan
d CA
PE to
their
ow
n av
erag
es (l
og n
umbe
rs).
Data Sources: Stephen Wright (1900 - 1952) and Federal Reserve Z1 Table B.102 (1952 - Q2 2013) for q, and Robert Shiller (updated) from Standard & Poor's for CAPE.
Slide 4. US Stock Market Value q and CAPE.
q CAPE
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But beware inflation near 4% US inflation and Dow Jones Industrial Average, 1966-1978
Source: Datastream
66 67 68 69 70 71 72 73 74 75 76 77 78 0
2
4
6
8
10
12
14
550
600
650
700
750
800
850
900
950
1,000
1,050
CPI (LHS) Dow Jones Industrials - Price Index
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But beware inflation near 4% US inflation and Dow Jones Industrial Average, 1985-1988
Source: Datastream
1985 1986 1987 1988 1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
1,000
1,200
1,400
1,600
1,800
2,000
2,200
2,400
2,600
2,800
CPI (LHS) Dow Jones Industrials - Price Index
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But beware inflation near 4% US inflation and Dow Jones Industrial Average, 1989-2003
Source: Datastream
1998 1999 2000 2001 2002 2003 1.0
1.5
2.0
2.5
3.0
3.5
4.0 ('000)
7.0
7.5
8.0
8.5
9.0
9.5
10.0
10.5
11.0
11.5
12.0
CPI F(LHS) Dow Jones Industrials - Price Index
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But beware inflation near 4% US inflation and Dow Jones Industrial Average, 2002-2009
Source: Datastream
(1) 2002 2003 2004 2005 2006 2007 2008 2009
0
1
2
3
4
5
6 ('000)
7
8
9
10
11
12
13
14
15
CPI (LHS) Dow Jones Industrials - Price Index
Source: DATASTREAM
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0
5
10
15
20
25
30
35
22
24
26
28
30
32
34
36
38
40
1929 1935 1941 1947 1953 1959 1965 1971 1977 1983 1989 1995 2001 2007 2013 Prof
its, a
fter d
epre
ciat
ion,
but
bef
ore i
nter
est a
nd ta
x, a
s %
of n
et o
utpu
t.
Prof
its, b
efor
e dep
reci
atio
n, in
tere
st a
nd ta
x, a
s % o
f gro
ss
outp
ut.
Data Source: NIPA Table 1.14.
Slide 63. US Profit Margins 1929 - Q2 2013.
Gross Net
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Stability of long term return from equities
-4
-2
0
2
4
6
8
10
12
-4
-2
0
2
4
6
8
10
12
1831 1851 1871 1891 1911 1931 1951 1971 1991 2011
% p
.a. r
eal r
etur
n.
Data Sources: 1801 - 1899 Jeremy Siegel , then Elroy Dimson, Paul Marsh & Mike Staunton 1900 - 2012 via Morningstar.
Slide 13. The First Remarkable Feature 30 Year Rolling Returns.
Bonds Equities Cash
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Stability of long term return from equities
-4
-2
0
2
4
6
8
10
12
-4
-2
0
2
4
6
8
10
12
1831 1851 1871 1891 1911 1931 1951 1971 1991 2011
% p
.a. r
eal r
etur
n.
Data Sources: 1801 - 1899 Jeremy Siegel , then Elroy Dimson, Paul Marsh & Mike Staunton 1900 - 2012 via Morningstar.
Slide 13. The First Remarkable Feature 30 Year Rolling Returns.
Bonds Equities Cash
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Deflation in the age of QE
‘Inflation is always and everywhere a monetary phenomenon’- Friedman
We do not live in a fiat system as so many countries manage/fix their currencies to others
For EM’s external surpluses dictate monetary policy
In fiat systems money is created by commercial banks and not by central banks
Demographic trends mitigate against credit and money creation by central banks
Page 13
Smaller US deficits and EM deflation
For almost two decades a widening US current account deficit was the basis for Bretton Woods II
Earned surpluses allowed liquidity creation and stable exchange rates in EMs
Since 2009, EMs have borrowed surpluses they did not earn
The round trip of capital creates liquidity in EMs
A country with insufficient surplus and liquidity can deflate or devalue and China is particularly vulnerable
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(250)
(200)
(150)
(100)
(50)
0
50
1Q
90
1Q
91
1Q
92
1Q
93
1Q
94
1Q
95
1Q
96
1Q
97
1Q
98
1Q
99
1Q
00
1Q
01
1Q
02
1Q
03
1Q
04
1Q
05
1Q
06
1Q
07
1Q
08
1Q
09
1Q
10
1Q
11
1Q
12
1Q
13
1Q
14
(US$bn)
US current-account deficit
Source: Datastream
Page 15
When does ‘money printing’ begin?
Source: Datastream
0
2
4
6
8
10
12
14
16
18
6/1/
675/
1/68
4/1/
693/
1/70
2/1/
711/
1/72
12/1
/72
11/1
/73
10/1
/74
9/1/
758/
1/76
7/1/
776/
1/78
5/1/
794/
1/80
3/1/
812/
1/82
1/1/
8312
/1/8
311
/1/8
410
/1/8
59/
1/86
8/1/
877/
1/88
6/1/
895/
1/90
4/1/
913/
1/92
2/1/
931/
1/94
12/1
/94
11/1
/95
10/1
/96
9/1/
978/
1/98
7/1/
996/
1/00
5/1/
014/
1/02
3/1/
032/
1/04
1/1/
0512
/1/0
511
/1/0
610
/1/0
79/
1/08
8/1/
097/
1/10
6/1/
115/
1/12
4/1/
13
GDP DEFLATOR (ANNUAL %) : Global World International
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US current-account deficit as % of GDP - A new era
(7)
(6)
(5)
(4)
(3)
(2)
(1)
0
1
19
80
19
81
19
82
19
83
19
84
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
(%)
Source: Datastream
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The shrinkage in the deficit is structural
The shale oil and gas revolution means fewer US dollars in the hands of foreigners
Chinese manufacturing wages have risen 3x since end-2007 in US$ terms, US hourly wages just 12%
The baby-boom generation is degearing and saving; and this means less consumption and fewer imports
If the US is to run structurally smaller deficits. then Bretton Woods II is unfit for purpose
EMs will deflate or devalue; either will bring a global deflation
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US visible trade deficit with China (% of GDP) - Shrinking
(2.5)
(2.0)
(1.5)
(1.0)
(0.5)
0.0
90 91 92 93 94 95 96 97 98 99 0 1 2 3 4 5 6 7 8 9 10 11 12 13
(%)
Source: Datastream
Page 19
China’s capital inflows and outflows (US$bn)
Source: Thomson Reuters Datastream
0
1000
2000
3000
4000
5000
6000
7000
8000
9000
2/1/
008/
1/00
2/1/
018/
1/01
2/1/
028/
1/02
2/1/
038/
1/03
2/1/
048/
1/04
2/1/
058/
1/05
2/1/
068/
1/06
2/1/
078/
1/07
2/1/
088/
1/08
2/1/
098/
1/09
2/1/
108/
1/10
2/1/
118/
1/11
2/1/
128/
1/12
2/1/
138/
1/13
2/1/
148/
1/14
Pane 1 BOP - CAPITAL & FINANCIAL ACCOUNT(DEBIT) : China ex Hong Kong and Macau(Country)
Pane 1 BOP - CAPITAL & FINANCIAL ACCOUNT(CREDIT) : China ex Hong Kong and Macau(Country)
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China’s gross external indebtedness
0
100
200
300
400
500
600
700
800
900
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
(US$bn)
Source: Thomson Reuters Datastream
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Family characteristic
Secured by resi property Instalment loans
Credit-card balances
Credit lines not secured by resi
property
Other Any debt Primary
residence Other
Age of head (years) Less than 35 37.3 3.3 65.2 48.5 2.1 5.9 83.6 35-44 59.5 6.5 56.2 51.7 2.2 7.5 86.2 45-54 65.5 8.0 51.9 53.6 1.9 9.8 86.8 55-64 55.3 7.8 44.6 49.9 1.2 8.7 81.8 65-74 42.9 5.0 26.1 37.0 1.5 4.4 65.5 75 or more 13.9 0.6 7.0 18.8 - 1.3 31.4
Family holdings of debt by age of head, 2007 and 2010 surveys
Source: Federal Reserve Survey of Consumer Finances
Page 22
US personal savings as a % of disposable income
Source: Datastream
Page 23
Five-year-TIPS-implied inflation versus MSCI EM Index (US$)
600
700
800
900
1,000
1,100
1,200
1,300
1 Jan 10 12 Oct 10 23 Jul 11 2 May 12 10 Feb 13 21 Nov 13 1 Sep 141.0
1.2
1.4
1.6
1.8
2.0
2.2
2.4
2.6 Five-year-TIPS-implied inflation MSCI Emerging Markets Index (RHS)(%)
Source: Datastream
Page 24
Gross External Debt Table
Gross External Indebtedness 3Q 2014 (US$bn)
Source: Joint External Debt Hub and World Bank Argentina 148 28% Belarus 41 53% Brazil 540 24% Bulgaria 49 90% China 874 8% Chile 137 52% Columbia 98 25% Croatia 58 100% Czech Republic 127 64% Ecuador 19 19% Georgia 13 81% Hungary 190 147% India 456 22% Indonesia 292 22% Kazakshtan* 155 34% Korea 429 28% Malaysia 213 68%
Macedonia 7 73% Mexico 419 32% Mongolia 19 158% Pakistan 56 24% Peru 61 29% Phillipines 58 20% Poland 370 67% Romania 120 59% Russia* 679 33% Serbia 36 80% South Africa 142 42% Thailand 143 38% Turkey 397 49% Ukraine 136 101% Uruguay 24 44% Venezula 119 27%
* exchange rate movements since end September 2014 will have pushed external debt to GDP ratios well about 35%
Page 25
Conclusions
The size of the US current account deficit is a key driver of global liquidity but it is not growing
Structural reasons - shale oil and gas, rising Chinese wages, baby boom degearing - stop the deficit growing
The de-gearing of the baby boom generation restricts the effectiveness of monetary policy
EMs, particularly in Eastern Europe, have borrowed too much in foreign currency.
Six years after the launch of QE we get deflation anyway and a move to government action
