Russell Napier, ASIP: 21 Lessons from History

Some investors give short shrift to analysis. They position portfolios to appease outside consultants, fickle clients, or their own institutional sales force. In many cases, they just buy what feels right. Other investors drown themselves in corporate roadshows, insane travel schedules, monstrous spreadsheets. and detailed company reports, completely oblivious to the lessons of history.

But astute investors appreciate both knowledge and thought by embracing what history has to teach.

This is the approach taken by financial market historian Russell Napier, ASIP. In his presentation at the 62nd Annual CFA Institute Financial Analysts Seminar, he shared a lengthy list of his favorite lessons from history.

“The best lessons,” he observed, “come from stupid people.” Where to find stupid people? The front pages of newspapers are good places to start, he said. After all, one gets on the front page by, first, having been right in the past and, second, by expressing certainty about the future — both of which sell newspapers yet fail to provide accurate forecasts.

Nowadays, when investors distill the art of investing into models and equations, they necessarily leave out philosophy, sociology, politics, and history, among other disciplines, Napier said. He urged investors to put back what their regimented and equation- and model-based processes filtered out.

Indeed, in the following list, the lessons are not easy to distill into numerical formulas:

• Take Sam Zell’s advice: Supply is boring. Demand is sexy. Look at supply as well as demand. “This is why ‘interesting people’ manage growth funds and boring people manage value funds,” Napier said.
• GDP growth has no relation to future returns.
• Gordon Pepper’s Law: When you see something unsustainable, calculate the maximum period of time that you think it can persist. Then double it.
• Follow Charlie Munger’s advice: “Never, ever, think about anything else when you should be thinking about the power of incentives.” The world is run by agents. And when agents have the wrong incentives, you get the wrong result.

• Governments like markets as long as markets produce the prices governments want. Governments aren’t neutral. They take sides.
• Mean reversion of corporate profits to GDP: In a free society, this will remain true. Who will take share? Creditors, workers, and increasingly pensioners.
• Monetary policy is the quantity of money, not the price of money. This lesson comes from Milton Friedman. Ben Bernanke took Friedman’s lesson and the US Federal Reserve has attempted to apply it. But the Fed is failing. Central bankers don’t create money, commercial bankers do. The US banking system is not growing enough to increase the money supply.
• Capitalism is not a moral system. It is amoral. On the heels of the Asian Flu, many investors were reluctant to get into Asian stocks until somebody went to jail. As it turned out, nobody went to jail, yet it was a great time to buy Asian stocks.
• The most dangerous form of speculation is the reach for yield. “Virtually everyone in the world, particularly those outside of finance, believes they have a moral right to 5% yield,” Napier said. If they can’t get 5% in a high-quality security, they will try to find it in a low-quality security.
• Populism is not a threat to countries with strong constitutions. When a populist chief executive runs up against a strong constitution, the constitution wins. Of course, not all countries have strong constitutions. In fact, many emerging markets have weak constitutions and fundamental property rights are at risk.
• The best way to predict if a country will default on its debt is to look at countries that have defaulted on their debt. If the foreign denominated debt-to-GDP ratio exceeds 35%, then the country will likely default.
• When equity valuations are high, they fall slowly with inflation and quickly with deflation. For instance, from 1900 to 1920, post-World War I inflation came as a surprise relative to the starting point, yet multiples fell rather slowly. From 1966 to 1982, inflation was once again a surprise, yet multiples still declined slowly. In contrast, from 1929 to 1932, multiples collapsed due to deflation.
• Tourism is the best indicator of an overvalued exchange rate.
• Never buy emerging market equity in a country with an overvalued exchange rate.

• Always buy equities when the CAPE is lower than 10, with three exceptions: when you believe in communism or fascism and there are no property rights; when you suspect your capital stock can be destroyed by war; or if your currency has entered a new currency regime with an overvalued exchange rate like Greece in the eurozone.
• Buy US equities when Citigroup goes bankrupt. As a proxy for the banking industry, Citigroup is too big to fail. Just about anything will be abandoned if it creates too much pain.
• Democracy normally comes with capital controls. How? Democratically elected governments get arbitraged by capital. When democracy and labor want to regain power from corporations, capital controls are inevitable.
• Heavy industry benefits from inflation. Small upstart companies benefit from deflation.
• Government debt held by a central bank ceases to be debt and becomes equity in the commonwealth. Consequently, the Fed will have a hard time shrinking its balance sheet and, therefore, will ultimately pursue the easier route, which is controlling the banks and the excess reserves that are created.
• Monetary systems fail every 30 years or so. In 1914, the monetary system fell apart as World War I pushed many countries off the gold standard. In 1931, the Bank of England left the gold standard. In the early 1970s, the Bretton Woods system collapsed. Today, the monetary system is once again crumbling. Any cyclical analysis is invalid during such structural shifts.
• Remember this statement from the 1810 Bullion Committee’s report to Parliament: “The most detailed knowledge of the actual trade of the Country, combined with the profound science in all the principles of Money and Circulation, would not enable any man or set of men to adjust, and keep always adjusted, the right proportions of circulating medium in a country to the wants of trade.” In essence, the committee said that central banking was impossible. Consequently, money is always in disequilibrium.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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