Albert Edwards Revisits The S&P 400, Still Sees Deflation To Hyperinflation
We knew it was only a matter of time before Albert Edwards would follow up to Russell Napier's call for S&P 400 with his own rejoinder. Sure enough, the SocGen strategist (who previously called for an S&P target in the same neighborhood) has just released the following: "Let me re-emphasise our 400 S&P forecast with sub-2% US bond yields" in which he says: "Amid the equity market enjoying yet another Fed induced mega-rally, many commentators have been left grasping (gasping?) for explanations for the continued low level of global bond yields despite the ruination of the public sector balance sheet. Most have latched onto QE2 as the explanation and hence expect a sharp rise in yields from June onwards as the Fed’s buying programme ends. We expect new lows in bond yields." The reason for that per Edwards, is an imminent bout of deflation, which is precisely what the Fed is hoping to create, in order to get the green light for the Jim Grant defined "QE 3 - QE N". Edwards, naturally recognizes this too: "Despite fully acknowledging the ruination of the government balance sheets as years of excess private sector debt are transferred to the public sector, we still expect to suffer another deflationary bust that will take government bond yields to new lows BEFORE government profligacy and the Fed's printing presses take us back to both double-digit inflation and bond yields. For now, we remain heavily overweight government bonds." In other words, just as we have been claiming for a long time courtesy of the Fed's so predictable Pavlovian reaction to always print more in response to deflation, enjoy 2% bond yields... just before they hit 20%.
More from Edwards:
Many think I am mad. But I am not the only commentator expecting a deflationary bust - the sort of bust that will take the S&P down to 400 from the current 1300. I recently watched John Authers of the FT Lex and Long View columns interview Russell Napier, formally of CSLA and a leading stockmarket historian. Russell's views are as interesting as ever and well worth 11 minutes of watching time. His views are similar to mine, although he articulates his thoughts far more clearly than I - Long View: Historian sees S&P fall to 400 - ft.com 16 May.
Where I diverge slightly from Russell is that the world he describes sounds pretty recessionary to me. Clearly the S&P falling to 400 destroys household balance sheets and consumption anew. And EM liquidity tightening could causes hard landings. In China, for example, a recent calculation showed FX intervention accounted for around one half of the country's runaway money supply which has helped propel the boom). My own view would be that despite the cessation of the EMs need to buy US Treasury debt as they curtail liquidity, weak economic fundamentals will drive US Treasury yields still lower in the near term. The printing presses being turned off will hit risk assets hard and that should boost Treasuries. So in my world, 400 on the S&P goes hand-in-hand with lower, not higher US bond yields. Ultimately I would concur that there is also going to be “The Great Reset” on US yields as well, but that will come after a frenzied orgy of balance sheet debauchment (both Fed and Federal) which will make events over the last three years look like an afternoon tea-party with the Vestal Virgins.
The chart below shows that not only is the Fed no longer (and never really) providing price stability but that volatility, contrary to the Fed's active involvement in the Russell 2000 is alive and well... in inflation/deflation expectations.
Yet there is a contrarian read to even near-term deflationary expectations. Exhibit A: China, whose long-imported inflation will have no choice but to come back and bite the US in the butt soon enough for a last push inflationary surge before all hell breaks loose.
But despite the cyclical slowdown in the US reducing inflation expectations, China's inflation problems should not be ignored. To the extent that the Fed's QE1&2 is driving Chinese CPI inflation upwards (and the CPI measure severely understates wider Chinese inflation with the GDP deflator running closer to 10% yoy), it is coming back into the US via higher US import prices of Chinese goods which is in turn impacting core inflation (see charts below).
We expect a global deflationary bust to reverse the clear inflationary pressures building from monetary debauchment around the world - more so EM than developed. If as last year we see a severe economic slowdown unfolding around the turn in the year, this could rekindle geopolitical tensions as the US is currently suffering a record seasonally adjusted (Datastream measure) trade deficit with China, disguised for the moment by favourable seasonal effects (see charts below). But from June onwards record reported deficits will increase trade tension sharply, especially if as last year we get US growth spluttering badly as QE draws to a close.
Great: so not only can the world expect hyperdeflation followed by hyperinflation, but may as well plug in a little hyperwar in the excel model for good measure.