Russell Napier’s Anatomy of the Bear, published four years ago, is “quite a cult classic” among investors, says John Authers in the FT. It explores the four great US bear-market bottoms of the 20th century. In 1921, 1932, 1949 and 1982, says Napier, the S&P 500 became compellingly cheap in terms of its cyclically adjusted price/earnings ratio (Cape). So when will the S&P’s Cape be back at bargain-basement levels again, signalling the end of the post-2000 equity bear market? What does that imply for the index’s price level? And what will get it there?
Many thought the S&P 500’s plunge to 666 in 2009 signalled the trough, but Napier points out that the Cape never reached levels consistent with great bear-market bottoms at that stage. Before valuations could fall that far, the US Federal Reserve threw liquidity at the market, encouraging investors to pile in, creating a big rally and postponing the final stage of the bear.
So what now? Deflation makes equities cheap, says Napier, and deflation is where the world is headed. “The world has been in disinflation since 2011; deflation is next.” Quantitative easing in America hasn’t boosted prices. In the past two years, US inflation has fallen from 3.9% to 1.1%. So real interest rates are on the rise, as is the dollar. Meanwhile, emerging markets are experiencing a major slowdown. They have had to combat recent inflation, while the recent sell-offs in emerging-market currencies and assets also bode ill for growth there.
The weakening yen means that Japan is effectively cutting the price of its exports, forcing competitors to follow suit. As a result, Asian countries are exporting deflation back to the West. As global deflation tightens its grip, the S&P’s Cape, now on 23, is likely to fall to ten or below, the sort of valuation previously seen at major bear market bottoms. That would imply a 70% fall in the S&P to below 500.