Things Fall Apart

Is everything about to fall apart?

Yes, surely. It’s just a matter of what you mean by “everything” and “about to.”

If this summer was any indication, Mother Nature is at wits’ end with humanity, and may soon decide to rid herself of the wholly onerous burden that is our species — by burning us up and drowning us all. We’ll deserve it, whenever it happens.

But we’re an invasive species. It’ll probably be hard to eradicate us overnight. Climatic oblivion is a glacial process. (Get it?) The end probably isn’t nigh. Your grandchildren might witness it. Mine won’t. Because I have no children, and children, I’m told, are a necessary precursor to grandchildren.

On the bright side, future generations of US conservatives will asphyxiate rich. The portfolio of oil and gas companies they inherit from parents and grandparents who cared more about money than whether their progeny would have air to breathe and water to drink will still be paying handsome dividends.

If you mean “everything” in the narrow context of markets, and “about to” is a synonym for “imminently,” then the answer to the question posed above is “probably not.” Betting on the end of the financial universe rarely pays off. Until 2020, the financial universe had imploded exactly one time since the Great Depression. A lot of people claim they predicted it. Only a handful actually did.

But, if you’re Albert Edwards, things are always about the fall apart, and Thursday was no different. “In the wake of [Wednesday’s] ‘hawkish pause’ from the Fed, another major landmark has just been passed,” SocGen’s incorrigible, but affable, contrarian wrote. He cited the 10-year. Yields are the highest since October 2007, “just before everything fell apart,” as Edwards put it.

Albert continued. “Meanwhile, investors are marveling at the equity market’s resilience in the face of rising bond yields. Funny, it was just the same back in October 2007 as the S&P hit a record high… just before everything fell apart.” (Are you picking up on the thread? Everything’s falling apart.)

Oil looks foreboding too, according to Edwards. “And to cap it all, the oil price in October 2007 was, like now, surging above $90/bbl on its way to $150. Three months later, after everything had indeed fallen apart, the US was in recession, bond yields and equity prices were collapsing, and the Global Financial Crisis was upon us,” he wrote, regaling thousands of loyal readers with the tale of the one time the financial universe actually did implode. “That can’t happen again, surely?” Albert wondered. It was a rhetorical question.

With the obligatory crash prediction out of the way, Edwards proceeded to recap his pseudo-famous “Ice Age” thesis, and the extent to which 10-year US yields rising above global equity yields suggests it’s in the process of unwinding.

“Having followed events in Japan, I believed that equities were undergoing a profound secular de-rating relative to bonds,” he wrote, describing the birth of the Ice Age. “In the deflationary brave new world, I argued that equities should yield more than bonds, just as they did back in the 1950s.”

Following the financial crisis, equity yields and bond yields “reengaged” thanks in part to QE, but stocks’ relative ‘cheapness’ “persisted — until now,” Albert said, dramatizing the moment circled in the chart above.

He taught more history. The Fed Model “seemed to work.” For nearly two decades, the relative cheapness of equities versus bonds (and vice versa) was a mean-reverting phenomenon.

But, as the Ice Age set in, markets “travel[ed] back to the 1950s when the equity dividend yield was always higher than the bond yield.”

Albert went on to suggest that equities may not be able to tolerate additional increases in yields, and called the recent rise in crude prices “shocking,” an exaggeration but who’s counting? That was the context (pretext) for a brief tangent on geopolitics.

Edwards played up the Middle East’s “pivot toward the China/Russian axis” (“of Evil?” or “Axis” proper?) and called the Beijing-brokered diplomatic truce between Tehran and Riyadh “among the most seismic geopolitical events of recent times.”

Two things on that. First, you heard it here… well, first. On March 10, just minutes after IRNA said a provisional agreement to resume diplomatic ties was reached, I published “In Geopolitical Coup, Xi Brokers Saudi-Iran Diplomatic Truce+“. A month before that, there was “China’s Middle East Pivot Is Hard To Ignore+“. Suffice to say there are still more questions than answers when it comes to Xi’s efforts to navigate the vagaries of sectarian strife in the interest of avoiding a scenario where China’s long-standing geopolitical affinity for the theocracy in Tehran collides with the economic imperative of nurturing Beijing’s burgeoning economic relationship with the Sunni monarchy in Riyadh.

Second, Xi will never succeed in smoothing that relationship over entirely. There isn’t an economic concern on Earth capable of bridging the Sunni-Shiite chasm. Iran will continue to fund Shiite proxy armies in the region, and the Saudis will do the same with regard to Sunni extremists, including the kind who terrorize Western capitals and fly planes into skyscrapers. The sectarian war will rage on, as it’s always done, and in the event it spirals out of control, I can assure you that no one in Tehran or Riyadh will give a single, solitary damn about Xi’s thoughts (or “Thought“) unless he’s thinking about sending weapons.

Circling quickly back to Albert’s latest, he fretted over the prospect that oil might leak into breakevens, pushing yields up even further. “I note with some trepidation that so far, US breakeven inflation hasn’t risen as closely with the oil price as it would usually do,” he wrote. “Indeed, the rise in nominal yields recently has been entirely driven by a surge in real yields, as GDP estimates are revised higher.”

In addition to the market’s “upgrade” of the US growth outlook last month, another reason breakevens haven’t risen alongside crude (and one reason reals have) is that the dollar is, arguably, a petrocurrency now+. Its correlation with crude has been strongly positive during the latest run higher for oil. That helps blunt the impact of crude’s rally on overall US inflation, even as sticker shock at the pump is an obvious political liability for the White House.

Speaking of the White House (and as a quick geopolitical aside), note that one key reason for the Biden administration’s frosty relationship with Mohammed Bin Salman is that this week’s “positive results” in peace talks aside, the Saudis are still precipitating the worst humanitarian crisis on Earth in Yemen, where the Kingdom is engaged in a horrific proxy war with — wait for it — Iran, via the Tehran-backed Houthis. That’s your Saudi-Iran “relationship.” And guess who’s sending the weapons to Riyadh? Not Xi, and until someone else steps up to the plate with security guarantees and multi-billion-dollar defense agreements, the Saudis aren’t going to de-couple from their benefactors in D.C.

Edwards had one final warning for investors: “Beware, if inflation expectations begin to rise too, bonds will be in real trouble!”

Bonds are already in “real trouble.” Recall that US Treasurys are on track for a third annual decline. That’d be unprecedented. Never in the (short) history of a nation founded by history’s most celebrated traitors (the world’s most beloved slaveholders and dearest genocidal land-grabbers) have 10-year US government bonds or their “ancient” equivalents logged negative returns for three consecutive years.

If Treasurys do notch a dubious milestone this year, bond bulls shouldn’t complain. As Edwards will gleefully recount, bonds had a good run. 40 years is one helluva bull market.