“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.”
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?!