SocGen’s Albert Edwards on Tuesday weighed in on the tight link between the vaunted “duration infatuation” and various factor bubbles in equities, a hot topic in 2020.
“Anaemic economic growth and low inflation are keeping bond yields at Ice Age levels”, Edwards writes, noting that “these same low bond yields are driving valuation extremes within the equity market last seen in the late 1990s Nasdaq bubble”.
Let’s briefly review.
The market’s love affair with bonds went into hyperdrive last August amid a recession scare (exacerbated by convexity flows) tied to new tariffs. In early September, yields snapped back higher in dramatic fashion, causing multi-standard deviation unwinds across factors. That factor quake looked like the beginning of the end for the massive valuation disconnect between, on one hand, momentum/min. vol./defensives, and, on the other, value/cyclicals.
Fast forward to November, and a full-on, pro-cyclical rotation was in the works, as optimism around the US-China trade truce ran rampant and the assumption that the lagged effect of dozens of central bank rate cuts in 2019 would begin to manifest itself in better economic outcomes became the pseudo-consensus view.
Then came 2020, and with it, a pair of left-field macro catalysts: The assassination of Qassem Soleimani and the coronavirus epidemic. Each created a flight-to-safety. The bond bid associated with the virus proved durable, effectively undercut the reflation narrative and, at the least, delayed the unwind of the factor bubble mentioned above.
The valuation spread between defensive and cyclical stocks is now 2X what it was during the peak of the tech bubble, JPMorgan’s Marko Kolanovic wrote last week.
“Quality stocks with sound balance sheets have joined growth stocks on nose-bleed valuations while value stocks remain in the doldrums”, Edwards goes on to say, in his Tuesday missive, before asking: “How will this end?”
As you might imagine, Albert doesn’t think it will end well.
He sets things up be reviewing one of the latest notes from his colleague Andrew Lapthorne – it’s the same discussion we had last week in “All Hail The Titans“. Lapthorne wrote the following earlier this month:
With the bulk of US companies having reported, we have summed up the report and accounts posted so far. Despite strong markets last year, net income barely moved, with a rise of just 0.3%. More worrying is without the Big 5 companies (Microsoft, Alphabet, Apple, Amazon and Facebook), net income fell 7.5%.
The following visualization shows annual growth rates for companies in the S&P 1500 that had reported as of early last week.
Edwards proceeds to remind readers that his famous “Ice Age” thesis “was never just about the secular re-rating of 10y government bonds versus equities”. Rather, it was also “about the re-rating of certainty within the equity market relative to cyclicality”.
A constant theme over the past several years has been the tight link between bond yields (and the curve) and various equities expressions tethered to the duration trade – essentially min. vol./quality/secular growth/bond proxies against shorts or underweights in value/cyclicals.
The correlation between, for example, relative performance for quality versus value and 10-year yields has, at times, been nearly perfect.
“The skyrocketing valuations of both 1) quality stocks with sound balance sheets, and 2) growth stocks led by tech, closely mirrors the continued buoyancy of bonds”, Edwards continues, before underscoring the notion that “this re-rating comes at the expense of value and cyclical stocks [and] the valuation divergence has never been greater, even in 2001”.
Next, Edwards appears to reference a series of recent calls by some high-profile names that the boom-bust cycle is over (see here, for example). When he hears such things, Albert says he has to stop himself “falling off my chair laughing”. He notes that the performance of tech recently seems to “epitomize this confidence”.
Albert then makes a similar point to that driven home emphatically by Morgan Stanley’s Mike Wilson – namely that tech’s price outperformance has far outstripped its profit outperformance, creating a disconnect that probably isn’t sustainable even if you believe tech will remain buoyant.
But the key point is the following (and this is Edwards summarizing the factor bubble point):
In valuation terms the divergence of tech forward PEs from the overall market has only been a very recent phenomenon. And just as notable is the extreme divergence of valuations between tech and value stocks something not seen since the late 1990s Nasdaq bubble. One key difference with the late 1990s Nasdaq bubble is that it is now not just tech (and growth stocks generally) that have reached extreme levels (both in absolute terms and relative to value stocks). Quality stocks (with sound balance sheets) have also joined the party.
After that, Edwards delivers four straight paragraphs of what one might call “vintage Albert”, complete with zingers like these:
- A bubble in sentiment has taken over where incredible growth stories are put on incredible valuations because people want to believe
- I have an ugly vision of the future
- [When] we slide into the next recession investors will start to see profit warnings from their favourite growth stocks which were almost by definition never supposed to profit warn in a recession
- Low bond yields and anaemic GDP growth have pumped up these tech cyclicals masquerading as growth stocks, but lower bond yields will not inflate valuations [forever]
- Disaster awaits
Like I said: Vintage Albert.
In the coup de grÃ¢ce, he predicts a repeat of the Nasdaq collapse, says the “whole tech sector will likely implode” and sees a mass rotation into “real” growth names and value.
Many market commentators like to claim they are impervious to criticism and care nothing for tomato-throwing from the peanut gallery. In most cases, that’s not entirely true – everyone gets a bit peeved at incessant criticism.
But when Edwards remarks (as he does near the end of his Tuesday note), that he “can almost hear the howls of derision at this heresy against the re-rating of tech”, I can confidently say that he really doesn’t care about those “howls”.
As one unfortunate CNBC anchor learned last year after an ill-fated attempt to castigate Edwards went horribly awry just months later when the global stock of negative-yielding debt ballooned past $17 trillion during August’s mammoth bond rally, criticizing Albert is akin to dogs barking at the moon – it’s an exercise in abject futility. Just enjoy the read.