Albert Edwards: "I Have Been Wrong – I’ve Been Too Bullish"

Tyler Durden's picture

And so with a slight delay, one by one the bears come out of hibernation. Today, SocGen's Albert Edwards is the first to remind us that no matter how high the Fed pushes stocks (as per Bernanke's now own admissions of the Fed's "third mandate"), it means exactly nothing for the economy, and the actual cash flow drivers that in a non-bizarro world validate any bull market, not the straight line bear market rally that has continued to defy gravity and reality for two years now. The catalyst as per Edwards, is once again the recurring threat of a demographic crunch, phrased in a way that only the SocGen strategist can: "Our Ice Age thesis called for a long secular equity valuation bear
market, just like Japan. Most reject the comparison with Japan,
especially with regard to the US having better demographics. Indeed I
felt that beyond the lost decade and secular bear market, the US outlook
was much more upbeat that Japan’s. But now, I am thinking I might have been too bullish....I haven’t really cracked this one but chatting this through with a number of people, I would suggest that although GDP growth may be more closely related to the absolute growth of the working population, asset price inflation may be more closely related to the proportion of workers in the general population. If that is the case, as the former baby-boomers start to retire this burgeoning cohort will tend to liquidate assets. This only exacerbates the secular bear market for property prices (which have already begun to decline again) as well as the equity market. This means that Bernanke for all his efforts may not be able to prevent the secular valuation bear market fully playing out until rock bottom valuations are reached." Oops.

More rhetorical brilliance from Edwards:

The sell-side and buy-side are locked in a steamy embrace, with the sweet scent of optimism acting like a most potent aphrodisiac. Equity bears are now an endangered species, just as they were in 2007. I have long held to the Japanese template for what is now occurring in the US and the UK. I have long believed that a lost economic decade was an inevitable consequence of the gross mismanagement of central banks. Our Ice Age thesis called for a long secular equity valuation bear market, just like Japan. Most reject the comparison with Japan, especially with regard to the US having better demographics. Indeed I felt that beyond the lost decade and secular bear market, the US outlook was much more upbeat that Japan’s. But now, I am thinking I might have been too bullish.

All hail bountiful Ben. There we were at the end of August – with the S&P down some 6% and the economy maybe heading for a double-dip – and lo, with the promise of QE2 coming down the tracks, the market managed to put on some 16% in the final third to leave us up a respectable 13% for the full year. Ben’s November article in the Washington Post explicitly spelt out the policy – “higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion”. -link. And so it came to pass. From the end of August stocks rallied. Leading indicators recovered. Spending increased. Jobs picked up. A virtuous circle indeed. Unfortunately, though, policy makers have yet to learn the lessons of the Great Recession. Basing economic growth on loose monetary policy driving up asset prices is simply doomed to failure.

As far as the sell-side is concerned, I feel like the last bear standing. But we have been here before. Nevertheless, beyond the Ice Age adjustment (which still has a long way to run), I had entertained hopes that the US might not fully replicate Japan’s debacle once de-leveraging was complete, due mainly to more favourable demographics. A client kindly sent me the chart below. I am no longer as optimistic as I was – at least not until 2030.

To be sure, a superficial analysis of demographic trends does not highlight the danger lurking beneath the surface:

When one examines the UN data Japan’s terrible demographics are self-evident (see chart below and link). Having said that, contrary to what is generally assumed, rapid population growth is not a sufficient condition in itself for rapid economic growth. But if human inputs alone determined GDP growth, the US outlook is favourable indeed – even relative to China.

But it gets much worse: If Edwards is correct, and it is not the working population but the working population as a % of total population that matters (which is critical considering the recent 25 year low in the labor force participation rate), then all those calling for a divergence between the US and Japanese case studies may be forced to reevalute their theses:

The reassuring picture painted for the US from the chart above contrasts sharply with that on the front page where it looked as if the US demographic situation was every bit as bad as Japan’s going forward – at least until about 2030. The difference is the front page chart  shows working population as a % of the total population. And although the working age population continues to rise throughout the forecast period, the number of retirees rises even faster.

The front page chart shows how asset prices in the US topped out 15 years after Japan (i.e. 2007 v 1992), entirely in line with the topping out of the working population as a share of the total. Now I haven’t really cracked this one but chatting this through with a number of people, I would suggest that although GDP growth may be more closely related to the absolute growth of the working population, asset price inflation may be more closely related to the proportion of workers in the general population.

If that is the case, as the former baby-boomers start to retire this burgeoning cohort will tend to liquidate assets. This only exacerbates the secular bear market for property prices (which have already begun to decline again) as well as the equity market (see chart below). This means that Bernanke for all his efforts may not be able to prevent the secular valuation bear market fully playing out until rock bottom valuations are reached.

And lastly, to underscore his thesis, Edwards proceeds to demonstrate the Tobin q and Shiller PE, which as we noted very recently, both indicate a 50% overvalyed market.

And with some key equity valuation measures still some 50% above even their average levels (see chart below), the bear market may be far worse than I had previously supposed.