You won’t be surprised to learn that SocGen’s Albert Edwards doesn’t think the rout in US equities has gone far enough.
Specifically, he calls the notion that US stocks are “cheap” (on an ERP basis) or have discounted a recession, “utter poppycock”.
“The toxic fallout from the coronavirus pandemic’s bursting of the Fed’s everything bubble has collided with the grotesquely over-leveraged and vulnerable US corporate sector”, Edwards writes, in a Thursday note. “This puts equity markets in an even more vulnerable position”.
“For the past year, we have used the trading of [Boeing’s] shares as a prime example of the ‘zombie market’ environment”, he wrote, adding that while Boeing “has had countless negative stories over the past year, investors expressed greater concern as the company drew down on the rest of its $14 billion credit line [while] Royal Caribbean, Wynn and Hilton all announced they were tapping credit lines today too”. And then there was Blackstone and Carlyle both advising portfolio companies to tap loans to avert a cash squeeze.
All of that on the heels of multi-standard deviation events in credit spreads, both IG (the biggest widening in CDX since Lehman, for example) and HY (a six-sigma move in CDX and the biggest blowout in energy junk spreads in history).
In short, the acute panic gripping credit markets was already evident last week, but worsened materially during Monday’s chaotic trade. Here’s the anomalous widening in CDX.IG for those who need a reminder:
So, that’s what SocGen’s Edwards means when he talks about the COVID-19 panic (and also the collapse of crude prices) exposing the overleveraged US corporate sector.
Last week, Albert spent quite a bit of time explaining why the Fed model should no longer be relied upon, and for obvious reasons, that topic has come up again this week. Suffice to say Edwards is at wits’ end – by his own account. To wit:
Let me make one thing clear: I do not believe government bonds are expensive or that equities are cheap. And if one more person tells me the equity risk premium is very high and equities are priced for recession, I will scream. This is a variant of the failed Fed Model which strategists should have given up long ago as discussed last week. In the Ice Age, with the threat of outright deflation, both bond yields and PEs will be rock-bottom low.
For the sake of Albert’s sanity (and if you already think he’s insane, well then that’s just all the more reason not to exacerbate the situation), don’t tell him that stocks are cheap on a relative basis.
As far as where stocks go from here (i.e., after falling into a bear market on Wednesday) Edwards writes that “full-blown equity bear markets typically see many 10%+ technical rallies usually triggered by policy easing, on their way down a very deep and dark hole”.
“This is normal”, he writes.
Those interested in a more complete discussion of Albert’s critique of using conventional valuation models in unconventional times (so to speak) can read more in “As Market Crosses Another ‘Ice Age’ Milestone, Albert Edwards Looks Ahead“, but the following passage is straightforward enough for Thursday:
I read that equities are now cheap, especially using valuation tools that incorporate the record low bond yield, like the equity risk premium. I wrote last week about how the whole TINA concept was misguided, but just take a look at the still elevated forward PE for the S&P when set against last year’s slump in analysts’ long-term (LT) eps expectations (see left-hand chart below).
Although US equities are now 20% from their local highs, the PEG ratio is still elevated at nearly 1.5. “Let me know when this ratio has fallen to 1.0”, Albert says.
Oh, and if you were looking for some COVID-19 color from Edwards, he’s got that too. I’ll leave you with one last dour prediction (in case you weren’t already felling gloomy enough about equities). To wit, from Albert (with love):
The big death rate headlines will likely hit consumer confidence very hard indeed and deepen an already likely deep recession and equity market collapse, potentially causing a significant backlash against the current US Administration. These are dangerous times indeed.