Albert Edwards has a bear narrative. More than one, actually.
Albert’s collection of bear narratives is a lot like my collection of designer sweaters: He has one for every occasion.
This week’s story from Edwards is that analyst optimism’s rolling over, at odds with other indicators which’ve inflected for the better. The disparity, he warned, may presage some kind of downturn — macro, market or both.
After alluding briefly to the RRP liquidity buffer and the extent to which it facilitated a painless QT (thereby anesthetizing the market to Fed balance sheet runoff), Albert cited AI hype as the primary support pillar for what he described as “sky-high equity valuations.”
Maybe the “the AI revolution will drive corporate profits sharply higher,” maybe it won’t (Edwards did concede the plausibility of the AI story), but for now, his preferred measure of earnings momentum (the share of analyst EPS changes that are upgrades, measured using a six-month moving average to smooth out the noise) is fading. You can see that, sort of, on the red line in the figure below.
“This is not the stuff economic recover[ies]” are made of, Albert said, on the way to suggesting that flagging upgrade momentum might be a more useful cyclical indicator at this juncture than other metrics, including the Conference Board’s gauge.
You may be inclined to call that inconclusive as a recession indicator, and I wouldn’t disagree. But if you’re Albert, the change in analyst hope is “clear.” And clearly ominous. He illustrated the same loss of momentum using the six-month moving average (and the 12-month) for the share of EPS estimate upgrades for Nasdaq 100 stocks. Stalled analyst optimism, he went on, “is usually a good cyclical ‘straw in the wind’” if you’re trying to time an economic downturn.
Although many (or at least some) market watchers believe ISM manufacturing’s poised to snap out of a 16-month mini-recession, Edwards suggested the marquee gauge of US factory activity might head in the other direction — so, down, again based on sputtering sell-side analyst optimism. He did acknowledge that some of the ISM internals show just the opposite (i.e., that the headline index is more likely to inflect higher), but disagreement is what makes a market, as they say.
The most interesting chart from Albert’s latest was doubtlessly the visual below.
That’s exactly what it says it is: The analyst optimism series with the YoY change on the S&P.
“Is this profits backdrop really consistent with the S&P rising by one third in a year?” Albert wondered. It was a rhetorical question.
“Maybe it’s all about Fed-induced liquidity after all,” Edwards said.
We are neither at the troughs of investor fear, estimate cuts, pessimistic expectations, negative surprises, and excessively low valuations, nor at the highs of investor ebuillence, estimate hikes, aggressive expectations, positive surprises, and excessively high valuations.
We’re somewhere on the path from the former to the latter. I don’t have a good sense of how far we are along the path or how close to the end. There are negatives, Edwards points some out. There are positives. The diffusion index probably looks positive, we can estimate how long the path might be, but diffusion indices can turn rapidly and the path could get cut short by big negative surprises.
Strategists have to make those calls and good luck to them. I think that for regular investors, best to focus on getting the best ideas in the portfolio, maintaining risk didcipline, while keeping your ears cocked for creaking and snapping sounds.