Albert Edwards

There are a dozen significant economic indicators that are warning that the U.S. economy is heading into a recession.  The Dow may have soared past the 15,000 mark, but the economic fundamentals are telling an entirely different story.  If historical patterns hold up, the economy is heading for a very rocky stretch. But most average Americans are not that concerned with the performance of the stock market.  They just want to be able to go to work, pay the bills and provide for their families.  During the last recession, millions of Americans lost their jobs and millions of Americans lost their homes.  If we have another major recession, that will happen again.  Sadly, it appears that another major recession is quickly approaching. The following are 12 recession indicators that are flashing red...

With any and every asset-gatherer capable of forming a sentence being trotted out on business media to proclaim victory and elucidate on why "there is no where else to invest but stocks" and "the US is the cleanest dirty shirt," we thought it might be useful to reflect on just how clean that shirt can remain as the rest of the world's growth slows down significantly. In the last decade, there has been particular growth in inter-regional trade, with a dramatic expansion in trade vis-à-vis Asia, reflecting globalization. At the same time, the deepening in global trade relationships means that the potential for a sudden shift in demand in one region can have a more significant impact on the rest of the world. This has been seen particularly in recent years, with the sharp retrenchment in domestic demand in southern Europe affecting the economy of Asia, particularly Japan. Looking at the rate of increase in regional imports (which we assume is what the 'heads' believe will power the US 'clean' shirt) and the picture is ugly. And while copper is enough of a tell for most, even the IMF (usually extraordinarily optimistic) sees World Trade slowing dramatically - and given these interconnections, perhaps being the cleanest shirt merely shows the stains even more clearly when they finally hit.

"The late Margaret Thatcher had a strong view about consensus. She called it: “The process of abandoning all beliefs, principles, values, and policies in search of something in which no one believes, but to which no one objects.” The same applies to most market forecasts. With some rare exceptions (like our commodity analysts? recent prescient call for a slump in the gold price), analysts don?t like to stand out from the crowd. It is dangerous and career-challenging. In that vein, we repeat our key forecasts of the S&P Composite to bottom around 450, accompanied by sub-1% US 10y yields and gold above $10,000."

Recall the fate of the East German MZ motorcycle company (see picture below). Prior to the 1990 reunification of Germany these motorcycles were an extremely common sight (eyesore?) on the streets of London. But in what many saw as a cynical vote catching measure, Chancellor Kohl allowed the East German savings in Ostmark deposits to be converted into the Deutschmark at a one-for-one exchange rate (the black market rate was nearer to 10-1). The immediate euphoria of East Germans being able to spend their savings at a favourable exchange rate was replaced by gloom as East German industry was bankrupted at this wholly incorrect exchange rate.

A few weeks ago we pointed out something curious: despite the so-called massive "slack" in the US economy - the traditional alibi used by Bernanke & Co. to justify ongoing endless QE, labor productivity has slumped while labor costs have soared at the fastest pace in 11 months. This is a result that is directly at odds with the assertion that the structural unemployment for the US is still at 5%, and indicates that the New Normal baseline jobless rate is more likely well above, perhaps in the mid to higher 7% range (which also means that the Fed will never voluntarily end QE as the unemployment will not drop to 6.5%, and as for inflation, well, there's BLS' Arima-X-12 goalseeker for that). While the immediate implication of this is that central planning has merely broken yet one more law, that of Okun which maps productivity to GDP, a topic we have covered in the past, there is another aspect to what lies in the future, which is the topic of Albert Edwards' letter today. In it, he observes as we do, the rising labor costs, and the inherent inflationary pressures these bring, yet his thesis is that any inflation will be short-lived, and that unlike the mainstream which is advocating for a rotation out of bonds (apparently falling on deaf ears as inflows into bond funds are once more far greater than those into equities), he is suggesting to stay invested in bonds.

"Central Bankers and policymakers can’t stop themselves from interfering." To be fair on them (unusual in his case), SocGen's Albert Edwards admits the pressure to do something in the face of “bad” economic news is overwhelming. The general public or more inconveniently, the electorate, clamor for action from policymakers to counter any economic pain. Any ‘Austrian School’-type suggestion that it is best to let the cycle play out is derided as heartless and defeatist. Something can and must always be done. Whether intervention makes things worse in the medium to long run is an inconvenience that can be ignored until later. We feel Edwards pain as he "sheds tears of despair as [he] was reminded of the blundering incompetence of our overconfident policymakers, whose interventions, despite their best intentions, seem to bring about financial crises with increasing rather than decreasing regularity."

Presenting Dave Collum's now ubiquitous and all-encompassing annual review of markets and much, much more. From Baptists, Bankers, and Bootleggers to Capitalism, Corporate Debt, Government Corruption, and the Constitution, Dave provides a one-stop-shop summary of everything relevant this year (and how it will affect next year and beyond).

“Something bad happened in November…and it wasn’t merely Hurricane Sandy”, the NFIB chief economist Bill Dunkelberg is quoted as saying - see chart below and link. Even scarier than the decline in the headline measure was the 37% slump to an all-time low in those firms who believe economic conditions will improve over the next six months. That 37% drop is twice the previous record 18% decline, which occurred in the immediate aftermath of the Lehman’s collapse (see chart below). For those who might immediately retort that this is a sentiment indicator that should be used as a contrary indicator - you are wrong. It is a good leading or at worst coincident indicator. I would say this datum is more than consistent with the recession that Lakshman Achuthan of the ECRI has been warning of, wouldn't you?

We have long been pounding the table on what in our view is the biggest detriment to any future growth for not only corporate America, but the entire US (where, sadly, government investment IRRs just happen to be negative - a fact that most won't understand until it is too late, especially not self-anointed economic wisemen whose only solution to everything is "do more of the same" yet who thought the utility of the Internet would be eclipsed by that of the fax machine): the complete lack of capital expenditures at the corporate level, and lack of (re)investment spending. It turns out that, however, that there is more to the story, and as the following chart from SocGen's Albert Edwards shows, not only are companies using up what actual free cash flows they have for such stupid stock boosting gimmicks such as harebrained M&A (just look at the recent fiasco between HP and Autonomy to see how rushed M&A always ends), and of course buybacks, but they are now levering to the hilt to do even more of this. The last time they did this? The golden days of the credit bubble.

While the impact of the Fiscal Cliff remains front-and-center in everyone's mind, SocGen's Albert Edwards has another, more prescient, insight into why stocks are reverting. In his words, "commentators are worrying about an impending fiscal cliff, we have actually already stepped off the profits cliff." As we noted last week, the divergence between markets and macro suggest a rather ghastly echo of 2008; as the market is falling in line with the dismal outlook for profits (rather than the more upbeat macro economic data). As far as the latter, we are getting close to a cyclical peak - so macro surprises are 'as good as it gets' - and for the former (earnings outlooks), Edwards shows an unprecedented level of optimism about EPS going forward. As we proceed into the new year, Edwards expects "the combination of poor profits and poor economic data to prove toxic."

From Albert Edwards: "In 2005 when Alan Greenspan was being hailed as a “maestro” I wrote that his policies would ruin the world and history would judge him to be “an economic war criminal”. I now think Ben Bernanke’s policies will prove even more ruinous than Sir Alan’s (yes unbelievably he still retains his honorary knighthood). Hence we are lowering our equity weighting to 30%, the minimum possible. The last time I did this was 8 May 2008.... I'm reading some insanely stupid stuff at the moment. Okay, I know some of my writing is pretty insane, but when I read direct quotes and commentary about Bernanke's policy of driving up asset prices in general and equity prices in particular, I almost want to cry over the ludicrousness of this position. The Fed is pursuing the same road to ruin as it did between 2003-2007. I'm becoming more and more convinced that, Gloom, Boom, & Doom's Marc Faber is right when he says that "the Fed will destroy the world."

US large cap corp profitability has been enhanced instead of eroded by outsourcing simply due to final demand being reflated by credit growth. That the US consumer’s deleveraging has not yet actually been felt in terms of final demand being squeezed and that the Federal government is going to go from supporting demand to detracting with some degree of fiscal cliff effect going into next year.  In a highly leveraged economy where SMEs are not performing well as evidenced by numerous anecdotal pieces of information and the overall weak post-08 recovery, the US could easily slide into a structural type deflationary recession. This is likely to have negative ramifications in EM/ EM FX where many of these companies have also enjoyed strong performance and negative implications for commodities and commodity exporters.

Frustrated with the know-it-all bullish 'experts' on the Chinese economy lambasting wise boots-on-the-ground deep-thinkers such as Hugh Hendry and Albert Edwards; Marc Faber (who discussed this in detail in the clip we presented here) today set about correcting some of that vacuous chatter on China's dominance (with all its current stuffed inventory). Noting that the Chinese stock market is not exactly pointing to the growth everyone is relying on (and we add since the MAR09 lows it is only fractionally better than Spain), Faber brings up one chart (courtesy of The Bank Credit Analyst) to rule them all. Alongside the mega-bubbles of: Gold in 1970s, the Nikkei in the 80s, and the Nasdaq in the 90s, Iron Ore prices since the start of 2000 have them all beat - and recently (as we noted here) have begun to roll over.

Since January we have been pounding the table that 2012 is nothing but a carbon copy of 2011. Whether this is due to the limited imagination of the central planners, or a quota on the number of pages in the market's script, we don't know. What we do know is that since now everyone acknowledges that the two years have been fused into one, we suggest readers take a double dose of Dramamine ahead of what comes next, which can be easily seen courtesy of the following chart from SocGen's Albert Edwards.

SocGen's Albert Edwards reflects that we have a lot to learn from Japan's Lost Decade as a prequel to the current chaos the global macro-economy is undergoing. Drawing on work by Peter Tasker, Edwards notes the similar-to-current-Euro-thinking consensus view in Japan was that their banks were at the center of the economic woes and hence bank recaps were the turning point. Critically Tasker and Edwards disagreed, as "although the banking sector was indeed damaging the economy via a credit crunch, the banks were not the problem but a symptom of the problem: the true problem was deflation and the lack of stimulative policies. Indeed, Japanese banks did not start underperforming the overall market until 1997 as they became the victims of the economic weakness; they were not the origin of that malaise. And so it is in the eurozone. The Spanish banking sector is a victim of deflationary policies enacted at the behest of German economic orthodoxy. A bailout will solve nothing."