Albert Edwards is bearish. On stocks, of course. But on bonds too.
His dour outlook for the latter informs his skepticism of the former, although when it comes to making a bear case for risk assets, Albert’s possessed of an inexhaustible Rolodex of rationales which run the gamut from wholly plausible to… well, something less than wholly plausible.
“Inflation is heading up to 1970s levels, not (only) because of the US/Iran war, but due to the ominous secular themes of fiscal dominance and political weakness,” Edwards said Thursday. “We have entered a… secular bear market for government bonds [and] I expect to see CPI inflation return to the 10-20% range.”
That’s the kind of bold, no-apologies, no-cares declaration you can make when you’re tenured. Or, perhaps more accurately in Albert’s case, when you’re “strategist emeritus” at a tier-three bank.
Imagine being two years out of B-school in Goldman’s research department, walking in one morning and saying, to the chief rates strategist, “We’re in a secular bond bear. Inflation’s going to 20%. And that’s what I’m gonna write under you name in this Friday’s weekly.”
(“Owen, I’m gonna use my discretion and not tell anybody about this, but you need to go home and sleep it off. I’ll cover for you this one time, but this can’t happen again. And wipe your left nostril. There’s still some coke there around the outer edge.”)
Jokes aside, Edwards’s Thursday missive is actually pretty good. You just have to deflate (no pun intended) the “forecasts” to account for Albert’s hyperbole.
“The post-COVID fiscal arithmetic is so poor that government efforts to trim deficits are proving impossible without upsetting electorates that are still irascible after post-GFC austerity and the pandemic turmoil,” he wrote, adding that costly energy subsidies have made the situation worse in Europe.
The figure above’s just a simple yield chart for long-tenor Treasurys, OATs and JGBs. The bond vigilantes, Edwards said, are expressing “exasperation and dismay.”
Nothing to argue with there. Or anywhere in Edwards’s latest, actually. The issue — if that’s the right word — is just that insisting on the imminence of large stock corrections, to say nothing of stock crashes, is to hitch your wagon to something that simply doesn’t happen very often. Even if it “should.”
In this case, the thesis is straightforward and entirely defensible. “A secular bear market for rates is the mirror image of what I have experienced for almost my entire career since 1982, until the inflationary aftermath of the pandemic broke the spell,” Albert wrote. “Falling nominal and real yields were universally accepted to be the primary driving force of secular re-ratings in equities and asset price valuations generally.”
Right. So, if rates are instead condemned to a secular bear market, then financial asset prices should de-rate. No less than Howard Marks has made the same argument on any number of occasions post-COVID.
The figure above, from Edwards, shows how elevated bond yields can make stocks look unattractive.
One bit of pushback says that in a world of high nominal growth and high inflation, stocks are a hedge to the extent they tend to “keep up” with price levels — corporates pass along higher input costs to consumers, which means higher revenue and, assuming competent management, still-healthy margins. In theory anyway.
Albert countered by pointing to a slowdown in the pace of EPS upgrades. “We don’t live in a sugarcoated Barbie World,” he said. (Tell me — a manic-depressive currently on a downswing — about it.) “We live in a brutally unforgiving second derivative world.”
That’s true, but again (and at the risk of begging the question): Corporates live and operate in the nominal world. There’s a reason you often see high stock prices in high-inflation economies. Of course, if price growth’s totally out of control, the local stock market becomes carnivalesque, a reflection of the dark, societally corrosive comedy that is hyperinflation. But that’s not 10% CPI. Nor 20% CPI, for that matter.
Anyway, Edwards said investors shouldn’t be duped by this week’s new highs for US equities and stabilization in Treasurys. “An end to the US/Iran war may bring temporary relief, but [bond] yields are set to carry on rising due to fiscal dominance and monetary debasement,” he warned. That, in turn, “will plague the markets long after the war ends.”
A headline in today’s FT feed pointed to some evidence that the recent warning from Mohamed El-Erian. He suggested that the supply of money from the Gulf states was already slowing. Today’s story pointed to very recent borrowing by those former moneybags. Private bond issuance and such.
If this was to continue, who will step up and buy US Treasuries going forward? China? The Fed?
And Dear God, would it slow the roll out of more datacenters? Would that push up the value of owners of existing datacenters?
A lot of the value of the owners of existing datacenters derives from the assumption that they’ll own an increasingly large number of data centers in the future. While their cash flows would certainly stand to benefit, their multipliers likely would not. Good for their debt holders.
Of course he’s correct from a perspective that considers risk in a non-algo driven way. However, as you pointed out in a recent article, momentum doesn’t care much at all about what many people may consider as risk (e.g., inflation, etc.). It’s a bungee cord market that appears less and less likely to change until something really, really disruptive happens to economic conditions AND those who buy the dips–including the CTAs–get run over repeatedly for dip buying. Recent market behavior suggests the bungee cord is very strong. Eventually, more than handful will jump toward the New River expecting to bounce only to experience a different result.
If only there were people with unfashionable wealth that we could tax to help alleviate fiscal deficits and inflation.
Until that happens, Albert is going to keep the bond market on double secret probation.
*unfathomable
nah, you had it right the first time
Hah!
Unfashionable – like the NYC idea of a second home in the city worth more than $5 million. Or a cannabis company?
Seems like yield curve control is next
This would suggest one should load up on commodities + some fancy metal doorstops.
Albert’s notes are always good food for thought (and not always action).
The day Albert turns bullish is the day we hit a 1929-style market top.
I love Albert, but I am something of a permabear myself. (It is a lonely existence being right in theory much of the time, and still being wrong on your portfolio’s returns, ugh!)
Oddly, aside for the hyperbole, Edwards thesis is now common knowledge. Even Hank Paulson was on TV declaring imminent bond rout. Maybe the broken clock will have his hour at last.