Are you feeling bullish this morning or are you otherwise relieved that after about seven straight days of unrelenting “covfefe” from Donald Trump we finally got to hear fromXi Jinping who, despite having enshrined himself into the autocrat hall of fame by effectively adorning himself “President For Life”, is infinitely more stable than the (literal) WWE hall of fame inductee that occupies the Oval Office?
To be sure, lots of people are feeling pacified after Xi’s “conciliatory” keynote address at the Boao Forum in Asia. As noted first thing Tuesday, Xi’s speech was a bit short on specifics or, perhaps more accurately, short on time frames for implementing the specifics he did mention, but the point is, compared to Trump it was a breath of fresh air. And everyone is pretty excited about it judging by how equities performed overnight and in the morning session on Wall Street.
Ok, so what’s the point in reiterating all of that? The point is that when you’re feeling bullish, there’s nothing like a healthy dose of Albert Edwards to disabuse you of the notion that everything is going to be fine and as luck would have it, Albert gave an interview to Barron’s last week.
I somehow missed that article, but someone pointed it out to me on Monday morning and now I feel like I need to remedy that oversight immediately because everyone needs their weekly dose of Albert. When last we checked in with him, he was wondering if your “nostrils were filling with the sticky aroma of recession” (finally):
Before I leave you in his capable hands (courtesy of some excerpts from the interview), I do want to highlight the following picture of Albert that accompanies the piece because it is yet more proof that whatever you’re doing, Albert is just chillin’ – more content in his bearishness than you are in your bullishness:
That’s my dude.
From Barron’s (these are excerpts – the full interview is here for subscribers)
Barron’s: You’re well known for your long-term bearish view based on your Ice Age thesis. Tell us about it.
Edwards: I put together the Ice Age thesis just over 20 years ago out of following Japan closely. In 1996, when the West was deriding Japan as incompetent, we came to the view that what happened in Japan would visit the West. Japan’s bubble had burst earlier, and as a result, it moved toward outright deflation earlier than anyone else.
In Japan, secular rerating of bonds took place with a very long journey of falling central-bank-controlled rates in the short term and declining long-term interest rates, with occasional strong cyclical recoveries during the past decade and a half. As each new recession came along, the bond yield would fall to a new low, and equities would reach new lows. From 1990, Japanese equities embarked on a long secular bear market in valuation.
In the West, stock valuations—not prices—reached their peak in 2000, and the very close positive correlation between lower bond yields and rising stock price/earnings ratios began to break down. As in Japan, bond yields continued falling because of central-bank easing. That would bring about an absolute and relative derating of equities versus bonds, interrupted by cyclical recoveries. In other words, bond yields keep falling as stock valuations drop. For that to happen in the West, the credit bubble supporting higher stock prices would have to burst.
These secular equity-valuation bear markets don’t occur often and take many recessions to play out. We saw that in Japan. The U.S. has had only three secular equity deratings in history. The shortest took four recessions to play out; the longest, six. A secular valuation bear market for equities is when you go from extremes of expense to extremes of cheapness. Since the peak of the bubble in 2000, we’ve had only two recessions. This extraordinary rally is an interruption.
U.S. and European stocks have done well. When is it going to get cold?
The Federal Reserve managed to short-circuit this derating process. In 2011, when quantitative easing, or QE, really kicked in, equity re-engaged with bond yields and P/Es expanded. Like an artificial stimulant, QE inflated all asset prices away from fundamental value and from where they would otherwise have gone.
We haven’t seen the lows in bond yields. In the next recession, bond yields in the U.S. will go negative and converge with those in Germany and Japan. The forward U.S. P/E bottomed at about 10.5 times in March 2009 on trough earnings. That was lower than the previous recession. In the next recession, I would expect the P/E to bottom at about seven times, a lower low with earnings about 30% lower because of the recession. That would put the S&P lower than the 666 low of the previous crash, versus 2671 Thursday afternoon.
If a recession unfolds, easy monetary policy won’t stop the market from collapsing. It will play itself out.
When will the recession unfold?
The Conference Board’s leading indicators look OK for now. What’s different is that problems in the real economy aren’t being reflected in the stock and bond markets. What we may see is the reverse: The stock market and parts of the credit markets collapse and cause problems in the real economy. If confidence collapses because the equity market collapses, then a recession unfolds.
Will the next bear market be worse for the U.S. than for Japan or Europe?
It should be. Traditionally, if the U.S. goes down 20%, the German Dax, though it is cheaper, would tend to go down a little more. Maybe this time it won’t. Japan is the one market we do like now on a long-term basis, and one of the reasons is the buildup of U.S. corporate debt during these past few years. The big bubble is U.S. corporate debt. In contrast, Japan’s corporate debt is collapsing. Over half of its companies have more cash than debt.
What asset class do you favor in the Ice Age?
If the U.S. 10-year Treasury goes from 3% to negative 1%, that is huge return. In equities, it would either be Japan or, if you can invest only in U.S., then gold miners, as gold will exceed its previous $1,900-per-ounce high.
Is there a way to avoid this Ice Age or mitigate it? If you were the new head of the Fed what would you do?
I would stop worshipping at the altar of the financial markets. If pulling an economy along were the route to economic prosperity, then Argentina would be the richest country in the world by now. This is failed policy. What I would do is not intervene so much.
What is your reaction to the Trump tariffs?
Many thought after the election he would back away from these tariff promises. He has delivered tax reform, which is probably the most criminally insane piece of fiscal stimulus this late in the cycle. To take the fiscal deficit to 6% of GDP at this stage is utterly ludicrous, but he is delivering on his promises.
On tariffs, China will escalate. To a person, all economists think a tariff war is catastrophic for the global economy. This isn’t about economics; it is about politics, about appealing to President Donald Trump’s base. If China acts on its proposal to put on tariffs on soy exports to hit his base, or it switches from Boeing to Airbus, then you really know things are getting nasty.
Where might you be wrong?
The end game for the Ice Age in the next recession is always going to be currency wars, negative interest rates, and negative federal-funds rates. This recovery could go on for longer. You could get inflation that actually gets bonds sufficiently disturbed that yields break above 3% and enter a bear market. If bonds enter a bear market, I would be wrong on bonds, but that isn’t good news for equities.
Policy makers could always create inflation. Give everyone a check and print money and you will create inflation. Even though I’ve been calling for the Ice Age slipping into outright deflation, that is a signpost on the way to total global debauchment of currencies. Policy makers look in the rearview mirror and say easing hasn’t created inflation so far, so we’ll do more. People look in the rearview mirror too much.
You like U.S. bonds, but then eventually the government response will make them a bad bet.
Absolutely, people should look to hide in them as a haven over the next six, 12, 18 months. And, hopefully, if equities become cheap enough, then that is the real opportunity. But you have got to have cash to take advantage of those opportunities.
On that optimistic note, thank you.
K. Thnx. Bye!