Albert Edwards Explains How The Leading Indicator Is Already Back Into Recession Territory And Why The Japan "Ice Age" Is Coming

Tyler Durden's picture

Albert Edwards reverts to his favorite economic concept, the "Ice Age" in his latest commentary piece, presenting another piece in the puzzle of similarities between the Japanese experience and that which the US is currently going through. A.E. boldly goes where Goldman only recently has dared to tread, by claiming that he expects negative GDP - not in 2011, but by the end of this year. After all, if one looks beneath the headlines of even the current data set, it is not only the ECRI, but the US Coference Board's Leading Index, Albert explains, that confirms that we are already in a recesion. If one takes out the benefit of the steep yield curve as an input to the Leading Indicator metric, and a curve inversion physically impossible due to ZIRP and the zero bound already reaching out as far out as the 2 Year point (it appears the 2 Year may break below 0.5% this week), the result indicates that the US economy is already firmly in recession territory. Edwards explains further: "one of the key components for Conference Board leading indicator is the shape of the yield curve (10y-Fed Funds). This has been regularly adding 0.3-0.4% per month to the overall indicator, which is now falling mom! The simple fact is that with Fed Funds at zero, it is totally ridiculous to suggest there is any information content in the steep yield curve, which will now never predict a recession. Without this yield curve nonsense this key lead indicator is already predicting a recession."

All too obvious double dip aside, Edwards focuses on the disconnect between bonds and stocks, and synthesizes it as follows: "investors are finally accepting that what is going on in the West is indeed very similar to Japan a decade ago. For years my attempts to draw this parallel have been met with hoots of derision  but finally the penny is dropping." The primary disconnect in asset classes as the Ice Age unravels, for those familiar with Edwards work, is the increasing shift away from stocks and into bonds, probably best summarized by the chart below comparing global bond and equity yields - note the increasing decoupling. This is prefaced as follows: "The reaction of bond markets is wholly appropriate given it seems we are heading into outright deflation. The increasing divergence of bond and equity market yields that has been a key plank of the Ice Age will continue (see chart below). Equities will look increasingly cheap relative to expensive bonds."

And just like in China, with time stocks will become increasingly cheaper when compared to bonds, whose intrinsic value due to their cash flow generation will make them a preferred asset. Granted, during the Japanese "Ice Age" it was not the case that the entire world was leveraged to the gills, and sovereign insolvency was a household phrase. We have certainly entered a new regime, in which excess debt makes the certainty of future coupons increasingly problematic. Although, courtesy of the reserve currency status, the US is likely insulated for the time being from an outright collapse in bond prices. But that is a topic for another time, and, incidentally, Edwards touches on it at the very end of his piece (more below). In the meantime, one thing is certain, that stock on a relative basis will become ever cheaper. As such, the recent dramatic divergence between stocks and bonds which we have been charting almost daily, presents some great entry points in an ongoing attempt to short the market on both a relative and absolute basis. For those wondering what Japan predicts for relative values between stocks and bonds, the chart below has nothing favorable to report:

Here is how Edwards captions the chart:

The de-rating in Western equities continues to rhyme in a surprisingly familiar way to what we experienced in Japan a decade ago (see chart below). Another cyclical rally has led to a temporary pause in the structural de-rating process ? just as it did in Japan a decade ago. US equities looked cheap verses bonds last year but will look even cheaper next year!

Edwards' conclusion is troubling, as it confirms an observation we ourselves have had: in its aggressive intervention to provide a basis for an accelerated sugar high, the Fed threw the monetary kitchen sink at a multi-trillion deflationary collapse. In doing so, it did in deed conceive a dramatic bounce in stocks from a fair value that is still well in the mid-triple digits. If Japan has shown anything, is that reversion to a long-term mean is inevitable. Yet its decline was gradual. Our own will likely be a mirror image of the spurt to the upside. The Fed knows this, which is why we have no entered a period where the half lives of new and improved monetary intervention will be ever shorter, in many ways comparable to the Swiss National Bank's intervention in the CHF. If the market is allowed to find its natural place without endless Fed manipulation (and not necessarily of stocks: the outright open intervention of USTs, MBS, and monetary aggregates is sufficient), the plunge lower will be severe, dramatic and instantaneous. Which explains why on Tuesday everyone anticipates a new message of monetary loosening, regardless of the form it ultimately takes. However, it is unlikely that this will be the last, or even a material, QE phase, as otherwise prices, even those of core CPI  items, would have already risen. Alas, as deflation accelerates, and QE episodes become clustered and ever more frequent, the Fed is telegraphing that as we approach the endgame, it has little to no options left. The practial application of this be a plunge in stocks far more pronounced than the March 2009 lows. To wit:

Inflation continues to ebb away. In Japan core CPI deflation, at -1.5% is the worst on record. While in the US, the corporate sector is seeing its weakest pricing power on record ? even worse than that seen in the deflationary maelstrom during the Asian crisis (see chart below). We have consistently articulated the view that the severity of the current situation will only be appreciated when this current cycle ends in failure ? and that is not too far away. That will be the time that equities will plunge to new lows.

Will that be the end? Not at all. For as long as the Fed is in control of the US, and thus the world, it will do all in its power to preserve the wealth of the current kleptocracy. After all, aside from the bullshit about its dual mandate of keeping fake inflation and massively misrepresented employment low, this is its true prerogative. And to do that, the historian at the top has learned all he needs to know. Not from the Great Depression, mind you, but from the Weimar Republic's very own Rudolf von Havenstein. Indeed, as Edwards concludes, the penultimate phase will be fire, not ice.

And that, not March 2009, will provide the buying opportunity of a generation to hedge against the coming Great Inflation.

Yet whether it is fire or ice at the very end of the regime, is irrelevant. It will, after all, mark the transition to the next phase. And as such all legacy forms of wealth will be extinguished.

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dan22's picture

China's Inter-Company Lending Ponzi Dynamics

Another Chinese listed company is in deep financial stress, due to 1.3billion in shark loan debt. An angry mistress reported the corruption of the chairman of Shenzhen International Enterprise (000056) to the Chinese authorities. In 2007, the company shifted its core business from managing department stores to commercial real estate developing. Years ago, one of the mistresses of its chairman began to report his corruption to the authorities. It turns out that he has at least 4 young mistresses, and has sent two of them to study abroad. He is suspected of transferring the listed companies profit to his mistress’s firm.

China's Inter-Company Lending Ponzi Dynamics 

Hedge Jobs's picture

Cheers for this D22. Seems the real moral of the story here is not how much you borrow or lend, to whom, at what rates and what collateral is pledged.

as a corupt official, rule number 1 is: if you are going to keep a mistress,  you have to keep her happy!

I think our last chance if we are ever going to get out of this is to hope Benanke has an unhappy mistress.

greased up deaf guy's picture

"... about (the fed's) dual mandate of keeping fake inflation and massively misrepresented employment low..."

freudian slip perhaps?  hehe...

banksterhater's picture

I read somewhere that 60% of the LEI is stock prices, money supply and interest rates, so it's skewed to non-production by design. Who knew?

filletandrelease's picture

Not true...

Leading Economic Index Factor

1 Average weekly hours, manufacturing 0.2725
2 Average weekly initial claims for unemployment insurance 0.0322
3 Manufacturers' new orders, consumer goods and materials 0.0809
4 Index of supplier deliveries – vendor performance 0.0715
5 Manufacturers' new orders, nondefense capital goods 0.0192
6 Building permits, new private housing units 0.0263
7 Stock prices, 500 common stocks 0.0373
8 Money supply, M2 0.3248
9 Interest rate spread, 10-year Treasury bonds less federal funds 0.1058
10 Index of consumer expectations 0.0295

DoctoRx's picture

Money supply, int rate spread and stock prices = 46% weight.  Pretty substantial even if you are technically correct.  One wonders if ZIRP 4VA allows past performance of this weighting to predict future etc . . .

morph's picture

3% of that 46% is stock prices. 32% is Money supply. Interesting wording you chose.


blunderdog's picture

Anyone know exactly what all is included in "manufacturing"?  A decade or so ago, they wanted to add the fast-food occupation of "burger assembly."

Anyone else remember that?

dark pools of soros's picture

once they got rid of the McDLT they had to let that idea go... it did take skill to keep the hot side hot and the cool side cool



maddy10's picture

2 chinese Mccheese burgers please!

Conrad Murray's picture

I can't believe I've never seen that video before.  Thank you.

MrSteve's picture

I can remember when the Reagan administration ruled that ketcup was a vegetable for school lunch funding purposes but not when burger assembly was listed as manufacturing. Restaurants have always been service businesses.

rapunzel's picture

i remember when McD's first opened, back in the day. my brother and sister would drive with friends every day to eat hamburgers. i personally never liked hamburgers, cause of the mustard and ketchup and pickles. they would get so  mad that i had to order a plain one and they had to wait for me. so i just stopped that, and just ate the french fries, which at the time were tolerable. fast food = suck food. actually growing up swear i only ate plain pasta, no sauce cause it is R E D, and cereal, but was allergic to milk had to substitute. went to a Kellogg sponsored summer camp, so that worked out well only got to eat cereal. better now thanks, cogdis.

Silver-Is-Better's picture

 And as such all legacy forms of wealth will be extinguished.

That is such a wonderful way to end.

dark pools of soros's picture

land is still land and gold is still gold


i don't see any other 'legacy' wealth around..

Calvin Jones and the 13th Apostle's picture

It will, after all, mark the transition to the next phase. And as such all legacy forms of wealth will be extinguished.



That sounds very populist to me.  Something that would warm Huey Long's heart a little bit.

Maniac Researcher's picture

Ally with the Nazis to fight Stalin?

Jasper M's picture

That's a really well written piece. Pleasantly surprised a non 'inflation, toMorrow!'piece would get such fair treatment here on ZH.

homersimpson's picture

Any well reasoned article gets fair treatment here, regardless of topic. It's the boneheads who credit their skill after hitting blackjack 6 times in row are the ones that ZH readers spit on. It's pretty irritating when some permabull posts on here and says "I told you so that the market will go up" right after the market just went up 200 points on low volume day with no news (read: the "broken clock is right 2 times a day" theory).

An article on ZH that states gold is going way down would get credit on here if the author brought up valid points.


SheepDog-One's picture

Is Leo still running around saying theres about to be a huge drop in unemployment?

Ned Zeppelin's picture

Last seen he was looking off into the distance with that 1,000 yard stare,  mumbling about a liquidity tsunami that was on the way . . .

DoChenRollingBearing's picture

Just another article telling us how we are all completely screwed.


Buy gold and other PMs.  Pull out $500 (or your local currency) from the ATMs on Thursday.

doolittlegeorge's picture

i've never been fixed annuity fan always believing "they're the biggest scam ever" but I'm being forced by Mr. Market to reconsider.  Needless to say "you can't blame CNBC" since when have you ever heard of them interviewing "the chief variable annuity advisor from Prudential."  wouldn't it be nice to know if they might be buying equities, though?

Bear's picture

Variable annuities at SP 450 ... hold 10 years.

Mitchman's picture

Tyler, is there a link to the entire piece by Edwards?  Thanks.

DoctoRx's picture

And as such all legacy forms of wealth will be extinguished.

Very tentatively I am targeting that when this fear/realization of its (potential) reality becomes widespread, that's the buying opp of a lifetime.  But who will have the money or the cojones?

Bone up on the detailed financial history of 1932-3 (pun intended).


Seer's picture

But, what the heck would anyone be buying?  Ponder that question really hard, for it operates on several levels.  Hint: there's a reason stuff is cheap- it's in excess, or it's not desireable.

AN0NYM0US's picture

Perhaps someone would be kind enough to refresh my memory.  When did QE 1 kick in and how did equities respond?  Followup, is there a correlation to equity prices? Was the July runup the inside money?

Implicit simplicit's picture

QE 1 was looked at as the way to get things going again, but when it was recognised that it wasn't working stocks starting correcting after the initial runn-up. QE2 will cause an initial smaller jump, but then be recognised for what it is- an admission of failure; then the stock market will head down a lot more.

hungrydweller's picture

Excess liquidity will flow to all asset classes just like it did during QE1.  Stocks, bonds, oil and gold are all higher since 2009.  The only things that have gone down are employment levels, regular hourly wages and purchasing power (for things we really need like food and energy).  The regular guys get screwed and the banksters and politicos get richer.  QE2 will be no different.

dan10400's picture

The Feds supposedly dual mandate is a crock of shite - low inflation and low unemployment.    The latter is just used as justification for ZIRP.    Structural unemployment will never be solved for an iCrap-obsessed populace whose deepest debates concern who will be kicked off from American Idol next week.

Seer's picture

That's how it was _sold_.  I think that most people here understand that it's all just a way to funnel yet more money to TPTB, in which case it was a smashing success.

QEII is a payoff to the next tier folks who went along with QEI.  Their cut, being that they aren't the leading players, will be smaller, but they'll still get free money.

QEII will be for the rest of us, and it will amount to pure marketing BS, with no actual product being delivered- read "no free money," as it'll really be the bill for QEI and QEII made to look like a gift!

spinone's picture

The cycilally adjusted PE (CAPE)  will have to revert to its historic mean.  It has been vastly overvalued for years, and will have to remain under its historic mean for years.  This means S&P below 400 for years.

I think I need to buy a gun's picture

i don't think we hit new lows, the currency takes on a 3rd world effect and gold and the dow meet between 15000-20000. If not higher. We will go down to maybe 8500 this fall but this is now a sovereign debt to the moon. Bernanke is going to release that gold revaluation tool shortly. Sniff sniff "he is going to change fed policy on Wednesday" now i know hes not raising rates......the gold revaluation tool is waiting

rapunzel's picture

guess who is moving back to T E X A S , after son graduates H.S. (janko?)

forbes list after, O P R A H     W I N F R E Y

cheeks, your not that rich‡

MountainHawk's picture

Sitting in my grad school classes, my finance professor tells us it's such a great time to buy a home...I chuckle inside. Classmates discussing how they decided to take advantages of all the great deals out there.

CashCowEquity's picture

LMFAO at your professor....too bad I graduated in 2008...i would have clowned the whole class

dark pools of soros's picture

land is still land..  if you really want to be wise tell them to buy the worst houses out there that are in good locations 

GlassHammer's picture

Buying a house is not like baseball since there is no such thing as called strikes. You can just let a home pass you buy since you only need to be right once. (Yes its a Warren Buffet line but God I love to use it)

At this point soon to be home owners can wait it out. You just have to tell yourself that its always better to buy a home at a lower price even if its at a higher rate instead of buying a more expensive house at a lower rate. 

If there was ever a time to be picky about getting a home now is the time.


bigkahuna's picture

To be clear, are all these comments about "buying" a home in reference to actually purchasing a home, or are we talking about leasing it from the bank? Purchasing a home outright is a great idea, but putting a mortgage on ones back in a soon to be unstable or collapsing currency is very risky at the very best.

Seer's picture

Further, one has to make the distinction between fuck-boxes and income-producing properties.  Income-producing properties are real investments, something that is able to give a return, can have value in any market.  NOTE: my idea of income-earning properties is not that which most equate to.

Edmon Plume's picture

When the ponzi falls, and hyperinflation takes hold, and you are bound to a mortgage interest rate, you could pay off your house with a single ponzie FRN - a trillion dollar one and get 999 billion back.  Use your change to buy a crust of bread.

Meanwhile, don't pay extra on the mortgage, and put that excess into gold, silver, wheat, and guns, not necessarily in that order.

Janice's picture

Those who can, do.  Those who can't, teach.