I was about 12 hours tardy on Thursday when it came to reading the latest weekly missive from SocGen’s Albert Edwards who, despite years spent relishing his hard-won reputation as the market’s most incorrigible bear, is an exceedingly affable individual, as far as I can tell.
He’ll forgive me for being late to peruse his most recent musings. After all, I was busy parsing and breathlessly documenting some of the worst economic data seen in modernity, a good use of one’s time, Albert would surely agree.
Suffice to say the deflationary bust is finally here, and it manifested this week in an oil price collapse so dramatic that the English language fails as a sufficient tool to describe it (see the oil archive for full coverage).
Although I pored over (and subjected readers to) every tedious, technical detail of crude’s collapse, I tried to keep the big picture in play at all times, especially as it relates to the deflationary impulse at a time when central banks are desperate to reflate.
Edwards emphasizes the same in his Thursday note.
“The slump in the oil price is not just technical. Other grades of oil, as well as other industrial commodities more generally, have been showing considerable weakness of late – and so they should”, he writes. After all, a “contracting global economy directly translates into falling industrial commodity prices”.
Albert jokes that he’s a “simple soul”, which means that when it comes to explaining trends in industrial commodity pries, there’s no need to reinvent any wheels (as my former employer used to chide, whenever I would spend too much time deep in the analytical weeds).
“Industrial commodity prices collectively are driven by the economy’s ups and downs”, Edwards says. It’s that simple, so if you’re looking for a real-time indicator, well, try base metals, for example:
Of course, central banks aren’t particularly keen on giving up all the economic ground they haven’t gained after a decade of stimulus (there’s a joke in there if you look).
So, they’ll hose markets with liquidity. For the optimists among you, that’s as good a reason as any to think you won’t get hosed buying the dip in equities. Here’s how I put it on Thursday morning:
If you’ve learned anything post-crisis, it should be that betting against policymakers with printing presses is perilous.
Especially when a pandemic has given them all the cover they need to toss moral hazard considerations out the window.
Edwards has a straightforward take on this, and I like it.
“It is a major mistake to believe that the liquidity central banks are hosing into the markets is somehow compelled to flow into any particular risk asset unlike direct central bank purchases”, he says. “Liquidity will flow into whatever momentum trade emerges as the winner”.
The reason I like that isn’t because I necessarily agree that central bank liquidity provision won’t ultimately boost risk assets via “classic” hunt-for-yield behavior (where investors are chased down the quality ladder and out the risk curve), but rather because Albert’s assessment is true in a broader sense – it’s a timeless observation that will retain some general explanatory power in all market environs.
He naturally thinks the bid will be for bonds. “The collapse in profits is highly likely to fatally undermine the argument that equities can look through the valley”, Edwards cautions, adding that he “expects instead ample liquidity to flow into government bonds”.
Bringing my own analysis in line with his, remember that over the course of the past five or so years, when it comes to stocks getting a boost from ample central bank liquidity provision, that liquidity has ended up in bond proxies and all manner of equity expressions tethered to the “duration infatuation” in rates. Hence the inexorable outperformance of so-called “slow-flation” plays, and the bubble in Min. Vol./Momentum versus downtrodden Value/Cyclicals.
In any event, Albert’s overarching message is that although “many equity bulls think it is inevitable that massive central bank liquidity will boost equity prices… we saw with industrial commodity prices between 2012-2016 [that] when the fundamentals turn against any risk asset, it struggles – despite ample QE at the time”.
The fundamentals certainly are not favorable for equities right now. Or, at least not if you’re the old-fashioned type who think profits matter and you’re not willing to “write off” the second and third quarters.
Edwards writes that market participants should watch commodities. “They should tell us when it is finally safe to rotate back into corporate risk assets.”, he says. “But that time is not now”.
It’s worth noting that if the dollar retains even a semblance of buoyancy in a deflationary environment, it will serve to make the situation worse. And not just for the US, but for the entire world, where US dollars grease the wheels of trade, commerce and finance.