THE ECONOMIC TIMES - ETMarkets | November 02, 2016
The rally in emerging markets seen over the last few months is not sustainable in light of the rising US dollar, said Russell Napier, global equity strategist. In an interview to Dia Rekhi and Sanam Mirchandani , Napier , founder of the Library of Mistakes, said he is holding back on India currently and is negative on emerging markets in the short term, but one needs to get over the high valuation as there are certain high quality companies available here. Napier had visited India recently to set up Vivekananda Library-the first international branch of Library of Mistakes at Pune's Flame University.
Central banks' commentary is shifting from monetary stimulus to fiscal policies to stimulate economies. What are your thoughts?
I don't believe that is going to happen seamlessly and without some pain first. Often it is only after things get particularly bad that the government comes to help you. If things get bad, say a recession or a financial crisis, we would absolutely get a coordinated global fiscal response but it is too early to talk about that. The two economies that are likely to have such an action are Japan and the United Kingdom but they are not big enough to change the outlook for global growth. UK is facing the issue of Brexit and that has given political capital to the Chancellor of the Exchequer to have a more expansive fiscal policy. In Japan there has been long growth stagnation.
What will be the consequences of the unwinding of the easy monetary policy?
Markets have moved a long way on the belief that central banking works. I see almost no evidence that that is working. If the conclusion is that it doesn't work and fiscal authorities do not step in, then the downside for the markets is very significant. Investors think they are playing with a safety net but there may not be a safety net.
Earlier this year you wrote that share prices could halve. Do you still stand by that analysis?
The CAPE ratio or Shiller PE, which is a measure of valuations and predicts future stock returns, is forecasting very low, but positive returns over a very long-term holding period. Historically, somewhere in that long-term holding period there is one very bad year. One very bad year could easily see the stock market halve. I think it can be very soon because if monetary policy is not sufficient then this is getting us to the time when it happens. There are also various weaknesses in the global system particularly with relation to the euro. Debt to GDP (gross domestic product) is at an all-time high.There are so many things that challenge the fragility of the system.
Is the global debt market in a bubble?
Yes, it is in a bubble and the yields are unsustainable but we have entered an era where there will continue to be no free market in these bonds. This negative yield curve in the market is not a market-determined thing. It is a central bank-determined thing. The governments of the developed world are not about to give up the control they have established over the bond market. That doesn't mean the control continues to the central bankers. They are quite capable and have historically, forced savers to buy bonds and control the yield curve. Bonds will be dreadful long-term investments, not because of the major decline in price of the bonds but because of the major rise in the inflation . There are two ways you can lose money in nominal terms or in real terms. There are nominal losses for the long-term investor in bonds. But the real losses would be significantly bigger than nominal.This yield curve that we have is not going back to a market-determined yield curve in the next 20 years in the West.
What would be the warning signals for emerging markets?
The number one warning signal is the rise of the US dollar. A lot of emerging markets (EMs) link their currency to the dollar and there are different degrees to which that is done, but China has done it very significantly. When the dollar is rising, that effectively tightens your domestic monetary policy and that is usually not good for asset markets.Many emerging markets have moved beyond strictly targeting the dollar, but China hasn't and so, it is a great threat for all the emerging markets. As the dollar rises, people will focus more on the risk of a major rapid Chinese devaluation. The second real problem with the rise in dollar is that it probably signifies that America is not running bigger current account deficit and so, the American markets can't run bigger surpluses. So, we have a structural risk out there, but it is all coming through the dollar for the short-term investor. Unless you believe the dollar will start going down we will have to remain very cautious about emerging markets. I don't believe the rally we have had since February is sustainable. A rapidly rising reserve currency is the most dangerous deflationary thing you could possibly have.
India is considered a mix of expensive valuations and strong growth prospects. Does it still appeal to you at this juncture?
I have long written about wonderful long-term outlook for India and compared it favourably to China. But if I believe in a rising dollar, particularly, if I believe in a weak remnimbi it would be dangerous and difficult to be in the Indian stock market. So I am holding back. But, one of my biggest mistakes as an investor is not to buy the Indian stock market and spend too much time looking at the valuation. I'm learning that you should maybe pay up a bit more, not because this is an emerging market but there are certain high quality companies in India. The history of finance is that you ultimately pay more for high quality companies and high quality managements. I should have learnt that 20 years ago, I would have been a richer man. The valuation is something that I will have to get over but in the short term, I am negative on all emerging markets.
Could we see a repeat of China-led turbulence?
The Chinese face a difficult problem as their monetary policy is based on the exchange rate policy that says that we can run surpluses against the rest of the world. That's a policy that can probably work when you are a relatively small economy, but you cannot, in the long run, be an economy the size of China and run current account surpluses against the rest of the world -particularly, when the rest of the world is running current account surpluses. China has to have an independent monetary policy. Once you target somebody else's exchange rate, you are importing their monetary policy. There is no reason for China to do that. It is more likely that it will devalue and move forward with a monetary policy which will be incredibly painful in the short run, but ultimately beneficial in the long run because China can pursue a policy more aimed at domestic growth than accumulating surpluses. I don't throw my hands up and say China will collapse, but I do say the exchange rate has to come down and that is a major challenge for all of us.
Do you see gold prices rallying?
Is it possible for me to be bullish on the dollar and bullish on gold simultaneously? Historically, you can't do that, but I am. The dollar will go up even without interest rates going up because it is relative to the euro and the yen. Things are going badly wrong for the euro and ultimately, wrong for the yen and so, the dollar goes up anyway. So, how on earth could I be positive on the dollar and gold simultaneously? If the dollar goes up it is going to cause a lot of problems in the world. One of the things is how the West responds to that. It responds through more controls -like controlling interest rates.The ultimate bull market for gold is inflation and also government control. This is why Indians are so interested in gold.