Scrutineer: Upbeat news? I must lie down

Published on Sunday 3 May 2009 21:53

FOR more years than I care to remember, Russell Napier, market analyst at CLSA and scholar at Edinburgh Business School, has been among the loudest of the growling bears.

Russell, who runs a course on the history of financial markets, was never convinced by the market rally of 2003-7 and felt that a major correction was overdue.

So I am intrigued to note that after the savage falls in markets over the past year, he has now turned from bear to bull.

For a terrible period from the bankruptcy of Lehman Brothers to February of this year, he writes, "it looked like many companies would not live to see the return of long-term earnings power.

"Now key indicators show that the deflation risk has materially diminished and investors can begin to look to the future, and equities, certainly relative to current risk-free rates, represent excellent value."

It wasn't a fear of recession which produced the 58 per cent collapse in the S&P 500 index, he argues.

This recession, he says, has been different from almost all post-Second World War recessions because it included the risk of deflation.

When the selling price of corporate goods falls, the risk of default on interest and the eradication of equity rises. Investors can only price equity based on its long-run average earnings power.

Equities will trade well below their long-run average earnings power, if there is a real risk of interest-rate default and the death of equity.

Since December he has been watching three key indicators in the US that would tell whether we had seen the bottom of the bear market.

"The good news", he writes, "is that there have been very material improvements in the price of all three indicators – Treasury inflation-protected securities (Tips), copper and BAA corporate bonds".

So why have conditions turned round since the dire outlook of December last year?

&#149 We now have a banking system that will be well capitalised with private capital and/or government capital after the stress tests.

&#149 Major amounts of credit have been raised in the bond markets.

&#149 M&A activity has started to appear, putting valuations on corporate assets for the first time in many months.

&#149 US mortgage rates are near record lows.

&#149 US home affordability has been rapidly restored.

&#149 Key indicators such as consumer confidence and the ISM Manufacturing Purchasing Managers' Index seem to have bottomed.

&#149 A major of inventory liquidation is nearing completion.

I had a similar list of upbeat points last week from veteran Wall Street commentator Ed Yardeni.

These included a revival in US consumer confidence in April and an edging down of the percentage of consumers who say that jobs are hard to get after rising in 13 of the previous 14 months.

This, he adds, tends to confirm the recent downticks in weekly initial unemployment claims.

California's median house price finally managed a meagre gain in April, rising 2.2 month on month after more than 18 months of declines.

And the stock market held up remarkably well last week despite the assaults of swine flu and poor first quarter GDP numbers.

Last but by no means least, I received an interesting take on markets from Mike Lenhoff, chief strategist at Brewin Dolphin, or Bell Lawrie as I am no longer allowed to call it.

A noticeable feature in equity markets, he points out, has been their reaction to news flow over the past weeks.

"Equity markets are paying far more attention to forward-looking indicators, such as various measures of business sentiment, a number of which have been better than expected, and far less attention to backward looking numbers.

"Two good and very recent examples of the latter are the UK and US first quarter GDP figures, both of which were worse than expected and both of which the markets promptly dismissed."

He argues that bad news is all in the markets and that "risk is now being re-priced on the back of a growing conviction that policy will work – indeed, is working … Be overweight risk assets and underweight defensive assets."

I can't remember receiving such upbeat messages in the past 18 months. And three in one week. I must go to a dark room and lie down.