Heisenberg Report

Albert Edwards Asks: ‘Could This Be What Blindsides Investors?’

It’s Thursday, and you know what that means. That means there’s a roughly 1 in 3 chance that Albert Edwards has a new piece out.

And if you were in the mood for some dire pontificating, you’re in luck because sure enough, everyone’s favorite incorrigible bear is out with his latest tri-weekly weekly.

If you were following along over the weekend, you know that the BIS just released their latest quarterly review and as we reminded you in our review of their review, Claudio Borio is someone who has been doing his best to warn you about the myriad land mines that litter the market landscape. Here’s what we said:

Listen, when the world finally does come to an end and the handful of people who survive the collapse are all sitting around a pile of burning trash and reminiscing about record high stock prices while eating expired cans of baked beans with rusty spoons, no one is going to be able to say that the BIS’ Claudio Borio didn’t try to warn everyone.

One of the things Borio mentions is the “conundrum” of looser financial conditions against a backdrop of policy normalization by the Fed. Edwards picks up on this on Thursday.

“So scared (or is that scarred) were central bankers after the summer 2013 taper tantrum, they have now gone out of their way to reassure financial markets,” Edwards writes, adding that as a consequence, “recent tightenings of monetary policy, whether by the Fed, ECB or Bank of England, were all perceived by markets as ‘dovish’ tightening and hence led to even more buoyant financial markets [as] policymakers are so scared the financial bubbles they created might burst that today what might be good for the economy is subservient to the needs of Wall Street.”

This is of course the dynamic that has found expression in Aleksandar Kocic’s “fourth wall” metaphor. Markets are consulted at every turn. The audience is no longer separate and distinct from a self-contained narrative unfolding on the stage. There is no preset course for the play. Forward guidance – transparency – means that market participants are essentially allowed to co-author the policy script. Withdraw of that transparency represents the biggest risk of all and the only thing that could force central banks to rebuild the fourth wall is a sudden pickup in inflation possibly catalyzed by deficit spending and amplified by deregulation in an environment of abundant liquidity.

But as Edwards goes on to note, everyone seems to be ignoring the tightening that’s taking place in China, where Beijing is attempting to do the impossible: they are attempting to deleverage and releverage at the same time. Of course the emphasis is on deleveraging and the squeezing out of speculation. The means of achieving this is cracking down on a labyrinthine shadow banking complex that amounts to some $15.5 trillion:

The idea is to “target” the tightening so as not to choke off credit to the real economy but invariably, there will be collateral damage.

What’s important to remember is that it wasn’t too long ago when concerns out of China very nearly triggered another crisis. I remember exactly where I was when my old boss pinged me and a colleague and asked us to immediately assess the impact of what, for US-based folk, was a late-evening yuan devaluation. It was just days later when the fallout from that devaluation triggered a black Monday for risk assets the world over with the Dow falling 1,000 points at the open on August 24, 2015.

The turmoil generally continued as China burned through its FX reserves to control the pace of the deval as the market naturally bet on a further slide in the yuan (this was not well understood at the time). I always harken back to the following from BNP’s Mole Hau:

What appears to have happened is that, whereas the daily fix was previously used to fix the spot rate, the PBoC now seemingly fixes the spot rate to determine the daily fix, and so the role of the market in determining the exchange rate has, if anything, been reduced in the short term.

The problems continued right up the infamous “Shanghai Accord” which put the brakes on things after turmoil in January and February of 2016 threatened to plunge the world into crisis. Here’s Edwards:

Almost two years ago, in the wake of China’s Aug 2015 renminbi devaluation and further turbulence at the end of the year, our January 2016 Conference saw attendance surge from the usual 650 or so to around 950. As well as our highest ever attendance of this annual event, that also marked the peak of concerns about the Chinese economy. And although China’s FX reserves continued to haemorrhage throughout 2016 as the central bank propped up the currency in the face of relentless capital flight, concerns lessened as the year progressed and strict capital controls eventually arrested downward renminbi pressure.

Well in light of recent events in China – where a bond market rout triggered at least in part by concerns about what new measures aimed at curbing speculation in AMPs might mean – it’s worth asking if, as Albert goes on to suggest, “it is the extrapolation of [a] period of calm in the Chinese economic and market conjuncture that might catch investors off guard.” To wit:

It is impossible to predict what might be the trigger to crash the global markets, but given the nature of these things it is highly likely to be something that investors are not currently worrying about, and China certainly fits that bill. China’s credit-fueled economic recovery since mid-2016 has been critical to the revival of global trade and economic activity around the world, but now, after puffing up the economy with credit ahead of the October Party Congress, the policy brakes are very firmly being applied once again.

So, Edwards asks, “could this be the trigger that blindsides investors?”

Maybe. But identifying triggers is inherently difficult. Readers are fond of parroting this line: “the question is when do we hit the tipping point?” Or, put another way: “what is the trigger?” It’s the search for Kocic’s skier’s scream that triggers an avalanche which exposes the “lie” in what previously looked like a “stable” accumulation of snow.

For Citi, searching for that “trigger” is an exercise in futility because “triggers are often latent – the long-term problem is obvious, but it is ignored until suddenly it explodes without much warning.” In essence, you are looking for that one skier standing at just the right place on the mountain at just the right time and then on top of that, trying to determine when he/she is going to scream. Put in the context of the fairy tale “The Emperor’s New Clothes”, Citi describes it as follows:

Spotting the specific trigger in time and predicting the magnitude of the cascade of events it sets off in markets is akin to picking out the right little boy in the crowd of onlookers and reading his mind.

The irony in that discussion is that it isn’t entirely clear who all of these people that are searching for “triggers” are. Because as Edwards reminds you, the bottom line for the delusional masses – lured as they are by ever higher highs in equities and ever tighter tights in credit – is this:

Investors don’t care.

Cue the honey badger.