Albert Edwards: Main Risk To Stocks May Be Opposite What You Think

Albert Edwards: Main Risk To Stocks May Be Opposite What You Think

“Optimism abounds,” SocGen’s Albert Edwards wrote, in the opening passage of his latest piece, out Thursday.

As you can imagine, Edwards suspects that optimism might be misplaced.

Taking the temperature of the financial press, he (correctly) observed that US market participants are feeling flush, and not because they’ve contracted viral pneumonia. Rather, because they suspect that fewer people will be prone to contracting it going forward and that the (relative) dearth of pestilence will allow for the reopening of the once teeming US services sector, just in time for summer.

“A wave of pent-up spending backed by a handy stash of surplus savings [and] fiscal authorities’ new ‘can-do’ (or rather a ‘can-spend’) attitude” has led commentators to “believe we are set for a repeat of the Roaring Twenties, most especially in the US,” Albert said.

That’s essentially the “summer bonanza” thesis I outlined earlier this week. He also noted the scorching reads on ISM manufacturing and services, both of which are threatening to recalibrate the y-axis (figure below).

For Albert, one risk is that this wave of optimism may be “cresting.” He cautioned against misreading PMIs (that’s been a persistent issue in the pandemic era), and noted that “other, more methodical surveys of economic activity tell an alternative story.”

For example, the Chicago Fed National Activity gauge (figure below) suggests “economic activity in February has fallen back to trend.” And while Albert said that “may be an anomaly,” it’s still worth “keep[ing] a very close eye on given the recent rally” and the extent to which “the market is now very vulnerable to cyclical disappointment.”

It’s funny — I said something very similar on Thursday morning in the context of the latest US jobless claims figures. “Expectations for a rapid and uninterrupted labor market recovery in the US are now running very high,” I wrote. “While one, or two or even three weeks of disappointing claims data likely won’t derail the overarching macro story, elevated expectations are inherently vulnerable to disappointment.”

The question isn’t so much whether the data will continue to come in hot in the near-term — it will. The question, rather, is what happens after that. The market is obviously obsessed with the notion of an overheat and a possible inflationary spiral, but that could totally miss the mark.

“The slowdown in the Chicago Fed Activity indicator… seems to be confirmed by their own diffusion index [which] shows a downturn,” Edwards went on to say Thursday, noting that traditionally, this has meant lower bond yields, “even outside of recession.”

More importantly, Edwards reminded market participants that what matters isn’t the absolute level of the deficit. Rather, what counts in terms of stimulating the economy is the change in the underlying cyclically-adjusted figure.

“Despite the huge Biden stimulus packages, a surprising fiscal cliff may yet await in the second half of this year,” he said, adding that “the OECD calculates to the best of its ability that the CHANGE in the underlying fiscal deficit soon moves towards tightening despite the huge absolute levels of the deficit.”

SocGen

And what happens to breakevens after the well-telegraphed (and partly mechanical) near-term inflation pop subsides?

Ultimately, Albert asked (and exclaimed) the following: “Instead of strong growth and rising bond yields being the main threat to equities, might it be the reverse?!”

Maybe! Who knows?!


8 thoughts on “Albert Edwards: Main Risk To Stocks May Be Opposite What You Think

  1. The main risk is that the stock market is at twice it’s average historical valuation (GDP to Stock Market Cap) as we enter a probable period of slow growth late this year.

    1. The major US indicies, sure. That’s because mega cap is very very expensive.

      Look down cap and at individual names. Many targets are there.

      I was working on one particular industry where the leading stocks are either near-monopolies or oligopolies, balance sheets are rock solid, valuation multiples are only about at the last 10 year average, the customer demand is strong and driven by external forces, there are no start-up digital disruptors, and no anti-trust threat. There’s only about 10 names in the industry. And every one of the charts looks great . . .

      This is a good time to be an investor. Not an easy time like 2016-2018. But a good time.

  2. Edwards may prove correct. One reason is that cycles, both economic and investment, are running so fast and passing through so quickly. Perhaps we have pulled all of the good news forward here?

    Meanwhile, the Covid numbers in Brazil and India continue to hit new records. But who cares?

    1. It’s my ferevent hope that one day soon that idiot Bolsinaro will be dragged in front of the International Criminal Court for committing crimes against humanity.

    2. I think that, sadly, you kind of answered the question. “Who cares?” “Not the markets.” And, therefore, not investors. Unless you own a Brazilian consumer products stock or something, the surging Covid crisis there is pretty far down the list of things to care about – as an investor, I mean.

      1. So far you are spot on, But I wonder how rampaging disease in two large nations will impact the herd immunity narrative in the US. We are not talking about Uruguay and Nepal here. Will we try to clamp down further on international travel? Will we try to seal our northern and southern borders once again?

        Then, there is the risk that Brazil & India will serve as giant “petri dishes” for the virus as it mutates further, perhaps challenging the effectiveness of current vaccines.

        Adding more straws to the camel’s back, two western single dose vaccines are now facing issues.

        But once again, who cares? Certainly not the risk parity and other algos!

        1. The two mRNA vaccines are effective enough on the variants that, as long as the US can get itself vaccinated – not a foregone conclusion, given the rate of vaccine refusal – then a resurgent pandemic in Brazil or India need not derail anything much in the US. Those vaccines can also be modified so quickly that, with sufficient money, variants can be addressed. Modification of the other vaccines is much more daunting.

          The AZN vaccine is in trouble, for sure. The JNJ vaccine, no so much. Regardless, the US will not need either vaccine. International efforts to expand production and sharing of the better vaccines will scale rapidly.

          Yes, re-vaccination every year or more is with us for the foreseeable future, and travel restrictions are certainly a possibility.

          1. Thanks jyl. Love your optimism. And so far, it has not paid to put much thought into the lower probability tails.

            But to paraphrase Joan Baez:

            No nation is an island
            No nation stands alone

            The notion that we can seal off the US from virulent new strains is a hope, not a fact.

            Yes, the mRNA vaccines may be upgradeable, but given the reluctance of many to even get the first shots here in the USA, what will be the take up rate on the inevitable parade of “booster upgrades” be ? Especially if each one is also a two step process?

            I am not so optimistic. Hope I am wrong.

            No wonder the Chinese see us as a weak, flailing old dinosaur!

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