SocGen’s incorrigible yet affable resident bear Albert Edwards is back and in a notable break with precedent, he’s turned bullish, predicting an imminent surge in global equities.
I’m just kidding.
He’s even more bearish than usual and he’s just got one question for you. To wit:
That’s right. Albert wants to know about your “nostrils” and specifically, whether they are inundated with the “sticky” stench of an economic downturn.
So for anyone who went into Thursday not knowing what a recession smells like, now you know: it smells “sticky.”
As usual, Albert makes some good points although really, he no longer has to. We’d all read him regardless because where else are you going to hear about his vacations in Jamaica (where he recently stayed at a hotel haunted by the ghosts of Marilyn Monroe and Winston Churchill) and where else are you going to find out what economics “smells” like?
If Albert ever retires (which seems unlikely), he’ll have a second career as a creative writer, that’s for sure.
As far as his latest note, he kicks it off by talking about the curve (which, you’re reminded, has resumed its flattening bias with a vengeance after a brief bear steepening episode around the early February market turmoil):
The rapid flattening of the US yield curve has been telling us for some time that all might not be well with the US economic recovery. But how can that be with consumer and business optimism at extreme highs, and the US manufacturing ISM making one of its very rare forays above the heady 60 mark? The optimists have had their day. This data merely reflects the illusion of prosperity. The markets are now sniffing out a rising stench from decaying debt. They say a fish rots from the head down. Unlike the 2008 financial crisis, this time I expect it is the Fed that will be held responsible for yet another debt crisis. Do not expect their independence to survive.
He talks a bit about how charge offs are rising far more rapidly at America’s smaller banks than they are at the big boys. Albert cites a number of folks on that, but ultimately he notes that it comes back to a February 6 report from TCW which you can find here. Here’s the relevant excerpt from that piece:
The Federal Reserve (FRED) graph in Exhibit 2 above illustrates rising NCOs for the entire U.S. banking universe. NCOs increased from a trough in 4Q15 at 2.9%, which coincidentally was the same quarter the Fed executed its maiden interest rate hike of this cycle. The larger U.S. banks that dominate credit card issuance have focused on prime and super prime consumers post the Great Financial Crisis (GFC), and have enjoyed a prolonged period of low charge off rates concurrent with the Fed’s almost decade long ZIRP. However, since 2015 the Fed has progressively raised interest rates from ZIRP while NCOs at the larger banks have started to rise, albeit off a low base. NCOs were 3.6% at 3Q17, closing in on a 4% rate, a level that matched the end of previous business expansions in 2000 and 2008. Interestingly, smaller banks (those not in the Top 100 by asset size) are experiencing far more rapid charge off rate deterioration at 7.9% (See Exhibit 3). Is this a precursor to larger banks experiencing much higher loss trends as well or just anomalous? Time will tell.
Yes, “time will tell”. Or actually “Albert will tell.” And the answer is “yes” (can’t you smell it?). Here he is citing David Rosenberg:
The Fed generally tightens rates until something breaks. David Rosenberg points out that since 1950 there have been 13 Fed tightening cycles, and 10 of them ended in recession (while the others have often ended in emerging market blow-ups, like the 1994 Mexican peso crisis). Surging delinquency and charge-off rates for smaller banks suggest the breaking point for the economy may come sooner than the Fed and bulls expect.
To be sure, Albert (and the folks he cites) are correct. The Fed is at risk of inverting the curve and the cycle is long in the tooth. As Edwards goes on to note, “by April, this US economic cycle will be 106 months long – the second longest in history as dated by the NBER.” Cycles do end (that’s part of being “a cycle”) and when they do, things get messy:
The only question is when the cycle will turn (central banks have unquestionably prolonged the current cycle) because as the old adage goes, being early is the same thing as being wrong (or something). For Edwards, the time to worry is “NOW” (bold, all-caps in the original”). He flags an uptick in residential mortgage delinquencies before pointing out the elephant in the room in a world where debt is the answer to every problem (here he cites William White, the former Chief Economist at the BIS):
White, now at the OECD, believes successive economic recoveries have been so reliant on debt that interest rates cannot rise to prior cycle levels, and hence there is a downside bias in each successive cycle. In particular, the extreme monetary policy measures taken since 2008 have inflated yet another credit bubble. As the Fed now tries to normalise rates with an eye on the real economy, unemployment and inflation, it will find that the newly inflated credit system is unable to tolerate even moderate rises in rates.
But the best part comes later in the note when Albert tells you what’s going to happen when a market crash and a leap in the savings ratio (which he says will undercut the U.S. economy) collides with the “iceberg of debt”. To wit:
The risk is now, with the tide going out on the equity market that the SR jumps higher, growth flounders, and the iceberg of debt rips open the hull of this supposedly unsinkable economic ship. If you want to blame someone, blame the Fed. And I am sure that is exactly what President Trump will do when he loses patience and moves to remove their independent status.
I’m not sure there’s much we could add to that to make it any more colorful, so we’ll just leave it there because no one does Albert Edwards like Albert Edwards.