The best way to invest in China
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Jody Clarke Oct 09, 2009
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In the first of an occasional series, Jody Clarke talks to investment analyst Russell Napier.
Is this just a bear-market rally?
Looking at all the periods when we have gone from deflation or low inflation to rising inflation, I've found that equities do well until inflation gets close to 4%. So this isn't a suckers' rally – I think it could go on until next year and into the year after. But equities are not cheap. In fact, they're a bit above fair value, so they can get a lot cheaper than this. For example, if you use all the valuation metrics, you keep coming up with a number of about 400 in the S&P 500, which is where the S&P could bottom, sometime in the next five years. So it's hard to recommend that investors buy equities when we have one final shock to come. And I'm more convinced every day that this shock will come through a disintegrating government debt market.
So you think the British government will inflate its way out of debt?
History suggests that for a large democratic government, defaulting on your debt is not an option. If you look at the post-World War II period, particularly in Britain, which was on the verge of bankruptcy after the war, the way they managed to meet every interest payment was through inflation. And in 1976 we ended up going to the IMF for a loan too. But there was no technical default on the British gilt [government bond]. You just lost 84% of your purchasing power.
How should investors protect themselves?
You have to be prepared for inflation and depreciation of the exchange rate. So a British or European investor must have more money outside their own currency in other assets than they normally would. You should have something that performs well during inflation. That could be index-linked gilts or gold. Exchange-traded funds (ETFs) are a great thing as well, as they allow flexibility. I think an ETF that prudently shorts government debt is a fine way for private individuals to try to cover their risks.
Do markets in the Far East still have more potential than Western ones?
Yes, and there's one big reason for this. What we've gone through is not a cyclical change, it's structural. Emerging markets have realised that they cannot rely on Western consumption anymore. All the data say it's dangerous to believe that emerging markets will diverge from the West, but I think that what we've seen is enough of a shock to convince Asian countries to change their policies to try and improve domestic consumption.
Is China a good way to play this?
I would warn individual investors about investing in China – it's dangerous enough for professionals. The key problem is this: most of their big listed companies are ex-state-owned. Some people in this country won't own Royal Bank of Scotland because it's owned by the government. Yet they'll flock to China to buy state-owned firms. I have no problem recommending China as a wonderful place that will meet its economic growth targets in years to come. But that's not the same as making money from equities.
However, you should absolutely align your global portfolio to making money out of China. You just don't have to own any shares there. Forestry is a great way to play it because this area will benefit from the rise of the Chinese consumer and their impact on commodity prices. I own Plum Creek Timber (NYSE: PCL), the biggest listed forestry stock in America. I own palm oil stocks too. The thing with timber and palm oil stocks is that it takes a painfully long time for the supply side to pick up, so you can do very well.
Were you always interested in finance?
Not particularly. I probably would have taken any job after university. It was just sheer luck. And that's the real problem with capitalism – it's largely pure luck. When it goes in your favour you pretend it's down to intelligence and charge a great big fee for it. That's what's gone wrong in the global financial system for the last decade. A lot of people got lucky, and convinced people that they were smart. And everyone backed them.
Who is Russell Napier?
The son of a butcher, Russell Napier, 44, knew that he didn't want to go into the family trade "the first time I had to take meat off a cow's head for pet food". From Donaghadee in County Down, Napier went on to study law. His first job after university was with Edinburgh-based Baillie Gifford, and he later became a respected market strategist with Hong Kong-based CLSA Asia-Pacific Markets.
But it wasn't until 2005 that he set himself apart from the pack with the seminal book Anatomy Of The Bear: Lessons From Wall Street's Four Great Bottoms. The book looked at the four occasions in the 20th century when investors could have made the most from investing in US stocks: 1921, 1932, 1949 and 1982.
Based on his findings, by looking at measures such as Tobin's Q ratio (which compares the market value of an index to the replacement cost of its underlying assets), he predicts the S&P 500 could fall as low as 400 by 2014, but that the next couple of years will see a bear-market rally as central banks try to fight deflation by printing money. Eventually those efforts will fail as rising government debt devalues the dollar and investors flee US assets. At this point, "equities will be incredibly cheap," and a new bull market will start.
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