It’s Thursday and do you know what that means?
That means that if Albert Edwards isn’t “warming his bones” on a his favorite beach in Barbados, there’s at least a 40% chance he’s got a new note out.
Today we (and by extension you) are lucky because Wall Street’s most beloved bear indeed has something new for us.
This week, Edwards is taking a look at volatility or, more appropriately, a lack thereof.
Essentially, he thinks that while equity vol has captured the market’s imagination, it might be that we should focus more on low vol in bonds, especially given the “fierce cross-currents” that have the potential to throw stones into an otherwise calm pond.
That said, just because Edwards thinks bond vol (sitting at its lowest level in four years) could be subject to near-term spikes, this is still consistent with his “Ice Age” thesis because… well… because if you know Albert, everything is always consistent with the “Ice Age” thesis.
Additionally, Edwards takes a critical look at the “profit renaissance” that’s supposedly underpinning low equity vol and record high stock prices in the US. He’s skeptical for a number of reasons, one of which we highlight below, the rest of which you’ll have to ask him for.
Oh, and much to our delight, he calls the reflation meme “Trump-inspired fake news.”
Below are some selected excerpts – specifically, the bullet point executive summary and one brief outtake from the section on corporate profits.
The last time volatility in the US bond market was this low (and complacency this high), 10y yields spiked up some 150bp in only four months as part of Bernanke’s ‘Taper Tantrum’. While we remain long-term Ice Age bond bulls, forecasting negative Fed Funds and 10y yields in the coming recession, in the near term investors should be open-minded. While on the subject of open-minded, what about the US profits rebound that is sustaining stockmarket euphoria? Are they really rebounding – as companies tell us? Well on one key measure we always watch, they are definitely not.
As equities continue to stretch upwards to new all time highs, we have become used to Vix, the most widely used measure of equity market volatility or investor fear, slipping ever lower. But the very recent slide into single digits has started to ring alarm bells that we are witnessing heights of complacency not seen even prior to the 2007 financial crisis.
The excellent Robin Wigglesworth asks in yesterdays FT The Short View, what should we make of a similar slide in the less followed Move measure of US bond market volatility (see chart below).
Robin finds the low volatility of bonds more perplexing even than that for equities. He notes that “while stocks have been underpinned by decent economic growth and buoyant corporate earnings, US government debt is subject to fierce cross-currents that should arguably produce some turbulence. Subdued inflation, easy monetary policy and investors’ appetite for safe government debt are big props for the Treasury market. But at the same time, the US economy looks to be in reasonable shape, the labour market is taut, the Federal Reserve is tightening monetary policy.”
With bond vol the lowest since 2013, we look at one of the key factors that might lead to a similar 2013-style, 150bp spike in yields. We then go on to look at one of the key factors Robin cites as underpinning the low Vix, namely the recent resurgence in US profits. Spoiler: the latest whole economy profits data suggests all is not well.
We remain wedded to our Ice Age thesis and we believe the reflation trade is Donald Trump-inspired fake news.
Whereas there is a good argument that bond volatility is way too low and might shortly spike higher, what about equity volatility? Surely as Robin Wigglesworth of the FT suggests, the fundamentals underpinning the equity rally are far more solid with profits having recovered briskly in the Q1 reporting round. My latest weekly Thomson Reuters email informs me that first quarter earnings have increased 15.4% from Q1 2016 and excluding the energy sector, earnings rose 11.1%. Double-digit profits growth… hey! No wonder equity investors are so relaxed, driving Vix into single digits. But let us not forget that although stockmarket profits are now rising once again after their 2015/16, energy induced hiatus, the equity market has run way ahead of profits for some years (see left-hand chart below). Hence the PE inflation the US equity market has enjoyed stands in stark contrast for example to the Japanese equity market (see right-hand chart below). This high valuation leaves US equities vulnerable