I’m undertaking a 1000-day reinvention project, blogging here daily to track my progress. In Thursday Thinker, I share a smart idea or theory.
Independent financial market strategist, researcher, and author Russell Napier shares Twenty-One Lessons From Financial History for the Way We Live Now in this YouTube video.
Here’s a PDF of the lessons.
His last lesson is “extrapolation is the opiate of the people.” Right now, with most investors overweight U.S. stocks (or even market weight, which is essentially overweight), there is significant extrapolation baked in — extrapolating that U.S. large cap equities will continue to outperform the world.
But his lesson eleven suggests caution, that even though US equity market valuations may continue to increase in nominal terms, you may lose money over a long period of time by staying in them:
Number 11. High equity valuations fall slowly when the surprise is inflation and quickly when it is deflation- our current repression creates a slow decline.
I’ve pulled out his commentary from the transcript and cleaned it up here:
There are two periods in US history where we get a very long decline in US equity valuations, 1901 to 1921, and 1966 to 1982. It takes that long to go from the peak valuation to the low. Now that didn’t happen from 1929 to 32; it was all done very very quickly.
Those long bear markets in equities with the value 1966 to 1982 where you lost a lot of money particularly in real terms: You can always look back with the benefit of hindsight and say what was the surprise? Well the surprise was inflation. Not that inflation was a bit higher, that inflation was so much higher that interest rates went to levels never recorded before in US history, outside perhaps the Civil War if you happen to live south of the Mason Dixon line.
Inflation brings equity valuations down much more slowly than economic collapse because economic collapse threatens the solvency of corporations instantly. Inflation takes a longer time to threaten the solvency of Corporations and that’s why it’s a long, slow decline.
US equity valuation are very high. Instinctively, as soon as I say that you’ve got a mental image of a share price chart going like this [moves hand straight down]. It’s just hardwired into us that something very expensive will fall very quickly. Not true. It doesn’t have to fall very quickly. The future for that particular market could be a world where the index in a volatile fashion goes sideways for many years but corporate earnings grow very strongly particularly in nominal terms. That’s what happened from 66 to 82 though you might say: well I don’t really care; I’m going to lose money in them anyway. Well, you are going to lose money in them anyway, but you should care because there may be other things out there which you can make money in.
You know if the US stock market is going to fall 70% it’s difficult to conceive that things are going to be going well in the UK or the Japanese market or anywhere else in that type of collapse. And that type of collapse will breed solvency issues for the financial system.
We saw it from 2007 to 2009, but this doesn’t mean it may end up with some significant solvency issues for the financial system. And therefore, this is a much better background to be an investor to seek positive real returns than the great collapse. Cyclically adjusted PE today 34 times for the US; the lows are usually under 10.
Now if we’re going to be there by next Christmas, I’m afraid there’s not much you can do about that to make any money. But if it’s going to take us 25 years to get there there’s plenty of things you can do to be making money. So consider what the future holds, is it deflation or inflation. If it holds inflation, I think equities are where you want to be, not the S&P 500 but there are stock markets all around the world on relatively low valuations that would do relatively well.
And in that prolonged period from 1966 to 82, value stocks did okay. I mean not brilliantly but they produced positive real returns because they charted cheaply. They had a low valuation they couldn’t really come down any further. Not much further anyway.
To summarize Napier’s idea: with inflation, nominal growth still carries company earnings up higher. In absence of a financial crisis, companies don’t become insolvent, at least not quickly. Meanwhile, inflation caused by financial repression (the government’s suppression of interest rates so they can pay their debt) eats away at earnings. In real terms, you lose money.
The alternative is to look around the world. Other equity markets aren’t so highly valued. Napier suggests in his lesson 14, “always buy equities below 10x CAPE unless the future holds– communism, war or a surrender of monetary independence with an overvalued exchange rate.” I’m not going to unpack that rule now, but the difficulty this poses for investors is that there are almost no countries right now with a CAPE ratio below 10, just Turkey. And who’s going to invest in Turkey?
We’re already seeing some sideways movement of the U.S. stock market right now. As of today, developed markets outside the U.S. have outperformed the U.S., rising roughly 5.2% to 5.2% compared to 1.5% for the S&P 500. And we’re seeing wobbles over the past couple days.
How high is inflation right now anyway? Isn’t it coming down?
The December 2025 CPI (Consumer Price Index) report released in January 2026 showed an inflation rate of 2.7% for the preceding 12 months. The most recent PPI (Producer Price Index) surprised to the upside with a 3.0% year-over-year increase in prices faced by producers. This came in higher than the consensus forecast of 2.7%. Wholesale prices jumped 0.5% on a month-over-month basis. This was driven by an increase in the price of services and the exhaustion of pre-tariff inventory cushions.
While Bloomberg economist Anna Wong suggests that the peak of tariff-related price increases that consumers face are largely behind us, other economists suggest they are still ahead of us. Preston Caldwell of Morningstar notes:
Core goods prices rose only about a percentage point cumulatively in 2025. But import prices (including tariff-related costs) were up nearly 10%. That means US businesses have been footing almost all the tariff bills. Why? It could be that their large stockpile of pretariff inventory allowed them to hold off on reflecting the cash cost of tariffs in their earnings reports. But that pretariff inventory is running out, and many businesses are planning further price hikes in 2026.
Furthermore, the rise in prices faced by producers indicated by the PPI increase as well foretell increases in the prices consumers face. RBC (Royal Bank of Canada) analysts write:
Of note, December’s Producer Price Index (PPI) shows tariff pressure remains in the pipeline and will continue to push consumer prices higher in 2026. The rise in December was driven primarily by services, but don’t conflate the story: the main driver of the spike was in wholesale trade for machinery and equipment. This is a sign of tariff pressure being passed through the supply chain, and it will continue to flow through final production stages and ultimately, to the consumer in the first half of 2026.
But tariffs are temporary – this is a one-time price hike
There are three reasons inflation is sticky right now and not likely to go away any time soon:
- The decrease in global trade due to trade wars. Global trade has acted as a massive deflationary engine for the last thirty years. Reshoring or “friend-shoring” is inherently more expensive. As companies build redundant supply chains and factories in higher-cost regions like the US or Europe, higher structural costs become embedded in the product’s price forever, not just for one quarter.
- The de-anchoring of inflation expectations. When consumers and businesses expect 3% inflation every year, it becomes a self-fulfilling prophecy. Workers demand 4-5% raises to stay ahead of perceive costs. Landlords and service providers build automatic escalators into their contracts.
- Most important, fiscal dominance and financial repression. Governments around the world currently have massive debt loads that they cannot afford to pay off with hard money. Their solution is to keep inflation slightly higher than interest rates. This slowly melts away the real value of the debt. Because the government needs this inflation to manage its debt, it’s unlikely to take any drastic measures (like 10% interest rates) required to kill it completely.
The period from 1966 to 1980 is the textbook example of an era defined by structural inflation and the first wave of modern financial repression in the United States. Following WWII, the US had a debt-to-gDP ratio of over 100%. Through Regulation Q, which capped the interest rates bankes could pay on deposits, and capital controls, the government created a captive audience for its debt. From 1948 to 1980, real interest rates (the rates you get after subtracting inflation) were negative roughly 50% of the time. This allowed the US to liquidate its debt burden without a formal default.
Inflation came in waves — in 1969, 74, and 79. Stock market valuations didn’t collapse in one week like they did in 1929. They rotted slowly. Every time the market tried to rally a new sticky inflation print would pull it back.
Arguments against this – “This time is different”
I don’t want to go in depth into arguments against this era playing out similar to 1966 to 1982. But I want to acknowledge what might happen instead, for intellectual honesty and to keep my perspective flexible. I try to avoid confirmation bias!
There are three reasons to think we may not be entering a period of structurally high inflation and a consequent grinding down of equity valuations:
- New technology especially AI will lead to deflation, not inflation. While tariffs will raise the price of physical goods on a one-time basis, AI and automation will radically lower the cost of services, coding, and administrative labor. Transparency and global competition via digital platforms make it much harder for companies to hikd prices without losing customers to a cheaper digital alternative. This didn’t exist in the 1970s.
- No wage-price spiral in the labor market. In the 1970s, a huge portion of the US workforce was unionized and had cost-of-living adjustments baked into their contracts. When prices went up, wages went up automatically, forcing prices even higher. Many economists believe that tariff-induced inflation will quickly burn itself out once consumers run out of money to spend.
- Energy independence. The 1970s period was defined by the OPEC oil shocks. The US was a massive net importer of oil, so energy prices hit American consumers hard. Now the US is the world’s largest oil and gas producer. The US economy is far more resilient to energy shocks than it was 50 years ago. An oil spike today puts money into the pockets of US energy companies, workes, and shareholders, partially offsetting pain at the pump.
Wrapping up
On balance, I find the inflationista argument more compelling than deflationista. My impression of the current state of AI is that it’s not likely to show up as massive deflation any time soon. Meanwhile, reduced trade and increased demand for real-world stuff (metals and minerals, especially) will drive higher inflation. Government debt will be managed via financial repression. And the result will be inflation, not a steady increase, but waves such as we’re facing in 2026 due to tariffs.
That’s why I’m tilting away from the U.S. large caps (especially growth) and towards rest-of-world equities and bonds, with a focus on value. I’m also increasing the allocation to commodity and commodity-related companies in my portfolio.