What did investors want to know more than anything else in January and February this year? Easy. They wanted to know when the carnage would stop. With the FTSE 100 20 per cent off its peak, the S&P 500 off 14 per cent after its worst-ever start to the year and European bank stocks down 30 per cent in the first six weeks of the year alone, they wanted to know when prices would finally bottom out. If only they’d bought a copy of the new edition of Russell Napier’s Anatomy of the Bear: Lessons from Wall Street’s Four Great Bottoms when it came out in late December, then they’d know.
This book, first published in 2005, would have helped in two ways. First, they would have known that they were in a bear market, not a bull market. And second, they would have had some sense of how that bear market would play out. This bit is key. It’s all very well knowing a bear market is happening around you, but what you really want to know if you want to make your fortune is when bust turns to boom. You want to find the point that marks the bottom — and be the one that is newly rich by the next top. It is for this you want to be reading Napier today.
He has done something so stunningly labour-intensive that you can be absolutely certain you aren’t ever going to do it yourself. He has figured out when the great market bottoms (in the US) have been in the past — 1921, 1932, 1949 and 1982, it turns out. He has then found and read around 70,000 newspaper articles published around those bottoms; noted that ‘perhaps surprisingly’ the same indicators worked to identify all four despite ‘the huge changes to the institutional framework’ around markets between these dates; and produced a ‘field guide’ to bottoms for the rest of us to use.
His key conclusion is a simple one: the catalyst that brings about great equity bear-market bottoms is always a ‘material disturbance to the general price level’; something that suddenly makes us all feel uncertain about both the future for corporate earnings and about the correct price for government bonds. The actual bottom comes after a period of deflation or a strong risk of deflation (something Napier calls a ‘doom machine’ for corporate profits) with prices starting to rise as other prices — and in particular commodity prices — stabilise. The one price to watch super-carefully? Copper. It gives ‘a particularly accurate signal of better equity prices’. Also watch interest rates (bull markets start as they are cut); corporate bond prices (they recover a few months before equities); and the economy (‘economic and stock market recoveries generally coincide’). Finally, it is worth noting the social history that Napier covers in the book. Can it be a coincidence, he asks, that all four great bottoms so far come in years that also mark ‘momentous change in American society?’ There was the birth of consumer society (1921), the birth of big government (1932), the birth of the military-industrial complex (1949) and the rebirth of free markets (1982). The answer, of course, is that it probably isn’t a coincidence at all: markets hate uncertainty.
You’ll be wondering where we are now. In the introduction to the new edition, Napier forecasts that 2016 will bring us a lot closer to the next bottom than we are now. There will be devaluation in China and intense worries about imported deflation. Then there will be frantic attempts by governments to reflate. Expect QE ‘for the people’, credit controls and exchange controls alongside various forms of debt forgiveness. Expect nasty ‘political friction’ along the way (this is your social upheaval). And then expect equities to, as they always do, ‘discount too much bad news, as they did in 1921,1932, 1949 and 1982’. That’ll be your bottom.
The good news of course is that if you get it right — you follow the road map Napier gives you — it works. You then buy when ‘prices have been pushed well below fair value’, just as they were in 1921, 1932, 1949 (the three best years ever to buy US equities) and 1982. I am going to confess at this point that I love Napier’s book so much that I wrote the foreword to the new edition. I said that professional investors would be neglecting their duty to their clients if they didn’t read it. However, given that neglecting their duty to their clients is all too often the default position — and the most lucrative position — for the financial industry, it is, I think, a must read for all of the rest of us too.