VALUE: After Hours (S07 E45): Why Value Investing Works in Financial Repression Regimes

During their recent episode, Taylor, Carlisle, and Russell Napier discussed Why Value Investing Works in Financial Repression Regimes. Here’s an excerpt from the episode:

Russell: Very fair. So, let’s give some numbers back to the 1966 to 1982 period, where if you go into the S&P 500, you obviously do very badly in real terms. But we have the French and Fama data for that period. They divide up into value. So, we’ve got value series going back a long time. Let’s say in 1966, you bought mid-cap value in the US. Now, you’ve got this dreadful performance from the S&P 500 in real terms. In real terms, you hold your value in mid-cap value. That’s pretty impressive given what was going on in the S&P 500.

In 1977, Buffett writes this famous article fortune called High Inflation Swindles the Equity Investor, there are lots of bits of that, but clearly points out that one of the things, is that you did get a march higher in the nominal rate and the discount rate and the valuations came down. So, part of the reason that equities perform so badly relative to inflation from 1966 to 1982 was you bought them at a very high valuation. So, if you can buy them at a very low valuation, it’s not clear to me that actually inflation is that negative.

Now, Buffett, I think he lists six other characteristics there. And at the margin, I think they’re probably negative. But there are lots of positives going on at the same time. As I said, nominal earnings growth from 1966 to 1982 for corporations is pretty strong. I keep stressing the word nominal, not real, but anyway.

So, for value stocks, that was a pretty good time to buy. So, if we’re in the same situation we are– That is not a situation where we were aggressively moving supply chains away from Russia in a cold war, because we’ve done that already. We were aggressively building armaments, we were aggressively building machinery to get us into space, but we weren’t aggressively moving our supply chains around the world. [crosstalk]

Jake: Guns and butter, wasn’t it?

Russell: Yeah. There’s an added impetus now to help those mid-cap value stocks. So, I look at this as a man who’s written the book about bear markets and generally seen as being quite gloomy and really get quite excited about where we are. When I started my career, the book that we all read was One Up on Wall Street by Peter Lynch, published, I’m going to say, in the mid-1980s. He talked about the excitement of going to the Midwest, going to the Rust Belt, and finding all these companies that nobody had visited for 20 years, seeing how cheap they were.

I think on a global basis, that’s true, again, because those companies have been so depressed by Chinese competition, so they may be in Korea or Japan or America. So, I think it’s an exciting time to be a value manager, an exciting time to be a stock picker, but as you know a lonely time to be a value manager.

Jake: [laughs]

Tobias: The Shiller PE received some criticism for lots of reasons that I don’t want to really go into, but you can find any other Tobin’s Q, or there are lots of other metrics that basically line up with Shiller PE. So, I don’t know how good those arguments are, but one of the–

For that Shiller PE chart that I look at for the US, it stands out that 1966 is a cyclical peak and 1982 is a cyclical trough. And in between those two, over that 16-year period, the S&P 500 went sideways. Yeah, just chopped around. There were lots of– [crosstalk] 1973, 1974 was obviously a terrible bear market and that was both bonds and equities. So, I was just wondering, if you apply your framework, your bear market framework, does that period feature at all?

Russell: Yeah, just a quick aside. This will sound unconnected, but it isn’t– In 1967, Elmer Bernstein, the man who wrote the soundtrack for The Great Escape and The Magnificent Seven, wrote a musical 1967 called How Now, Dow Jones. And the premise of the musical, is that this woman had a fiancé and the fiancé would only marry her when the Dow Jones went through a thousand. Pretty pathetic [Jake [laughs]…

thing.

But anyway, as you probably know, it did go through a thousand and then came down. So, it spent this entire time just [unintelligible [00:42:34] through. Whether the poor woman ever gets married in the musical, I don’t know. It’s not one that gets– [Tobias laughs] It’s star song, by the way. Maybe a sign of the times was called Step Away from the Ledge.

When people ask me to pick a period of what the equity market’s most likely to look like, I say, it is 1966 to 1982. Maybe we’d better looking at that in the context of a non-American market because America wasn’t really running much of a financial repression post-World War II. It does get into that as the Bretton Woods Agreement comes under strain, as American gold rush begins to drain, and that is one of the features of that period from 1966 to 1971, obviously is the attempt to stop capital outflow.

President Kennedy introduced the Interest Equalization Tax of 1963. Presidents Johnson and Nixon would often get corporates into the White House and say, “Stop investing overseas.” So, there’s an element of rising financial repression even in America. But for other countries, that have been underway for a long period of time. So, I think we can learn an awful lot from that period. That’s the one I would like to pick out, particularly, because if you pick 1945 to 1966, you’re picking low equity valuations, going to high equity valuations. But we are starting with high equity valuations. So, why not focus on 1966 to 1982?

That’s a period of war. America was at war. It almost, but didn’t quite impeach a president, because he resigned first. The city of New York, not the state, went bankrupt. We had a bankrupt bank, Franklin National Savings bank, which I think was the 12th biggest bank in the United States of America. If you look at any movies made in New York in the mid-1970s, it looks like Berlin 1945. This was pretty awful period of financial history, and value stocks produced positive real returns. Not big ones, but they did.

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VALUE: After Hours (S07 E45): Why Value Investing Works in Financial Repression Regimes

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