Consumers do not object to lower prices and neither should investors if they are buying rather than selling, writes Russell Napier in ‘Anatomy of the Bear’ ( >www.visionbooksindia.com ). Avoiding bears preserves wealth, but buying cheap in a bear market, given the positive real long-term returns from equities, is even more profitable, he adds.
Watching financial bears
The book, written as a ‘field guide to the financial bear,’ focuses on the very lucrative periods in history when equity prices had been pushed well below fair value and rebound was imminent.
Drawing inspiration from Yogi Berra’s quote – that ‘you can observe a lot just by watching’ – the author instructs that by watching the financial bears, we can observe the point at which a number of potential factors come together to signal the market can only get better. “Those factors include low valuations, improved earnings, improving liquidity, falling bond yields, and changes in how the market is perceived by those who play it.”
The 17-year wait
An alternative to the field guide is the wisdom of Jeremy Siegel based on an analysis of total real returns since 1802, that all an investor needs to do is hold for 17 years, and they will never lose money in the stock market. “If you sit out and ignore market prices, history suggests that in sometime less than 17 years the bear will simply go away, leaving your real purchasing power undamaged,” explains Napier, for the benefit of those who may have that time horizon.
In reality, though, very few investors may have such a long term in mind, as statistics show. For example, the average holding period of the 84 million stockowners in the US was just 12 months in the first half of 2005, according to New York Stock Exchange (NYSE); and the average holding period from 1900 to 2002 was just 18 months, the book cites.
Periods of price disturbance
A concluding chapter notes that a material disturbance to the general price level will be the catalyst to reduce equities to cheap levels. On three occasions – 1921, 1949, and 1982 – the disturbance was a period of high inflation followed by deflation, although in 1982 deflation was confined to commodity prices, the author narrates. “There was no initial inflation in 1932, but there was still a material disturbance to the general price level in the form of a severe deflation.”
In such periods of price disturbance, he finds there is great uncertainty as to both the level of future corporate earnings and the price of the key alternative low-risk asset (the government bonds), and this in turn leads to a decline in equity valuations.
Copper signal
The book’s lesson – from bear-market bottoms occurring during economic recession, and a return of price stability following a period of deflation signalling the bottom of the bear market in equities – is that stabilising commodity prices augur more general price stability ahead and signal the rebound in equity prices.
In Napier’s view, of all commodity prices, the change in the trend of the price of copper has been a particularly accurate signal of better equity prices. In assessing whether price stability is sustainable, he therefore advises investors to look for low inventory levels, rising demand for products at lower prices, and whether producers have been selling below cost.
Tactical takeaways
A section on ‘tactical conclusions’ has ready takeaways such as that recovery in the auto sector precedes recovery in the equity market; that an increasing supply of good economic news is ignored by the market during bear market bottoms; that many commentators will suggest the worsening fiscal position will prevent economic recovery or a bull market in equities but they will be wrong; and that decline in reported corporate earnings will continue well past the bottom of the market.
The bottom is preceded by a period in which the market declines on low volumes and rises on high volumes, the author describes. The end of a bear market is characterised by a final slump of prices on low trading volumes, and confirmation that the bear trend is over will be rising volumes at the new higher levels after the first rebound in equity prices, he continues.
“There will be large number of individual investors shorting stocks at the bottom of the market. Short positions will reach high levels at the bottom of the equity market and will increase in the first few weeks of the new bull market.”
Before you venture to identify the bear and its bottom, armed with these insights, there is a helpful caveat from the author: that, just as the possession of fur does not, of itself, permit the identification of an animal as a bear, the possession of any one of the features above should not be considered as constituting positive identification of its financial equivalent.
Educative read for players in the markets.
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