The punchline from Albert Edwards latest note:
Tapering is tightening, which inevitably ends in recession, bailout and tears
Our warnings throughout last year that an unravelling of emerging markets (EM) was the final tweet of the canary in the coal mine have still not been taken on board. The ongoing EM debacle will be less contained than sub-prime ultimately proved to be. The simple fact is that US and global profits growth has now reached a tipping point and the unfolding EM crisis will push global profits and thereafter the global economy back into deep recession. Our thesis on how EM would be pushed to crisis was simple, especially as we saw close parallels with the 1997 Emerging Asia currency crisis. We saw yen weakness further undermining an already weak balance of payments situation in the emerging world as a direct replay of 1997. A strong dollar/weak yen environment is typically an incendiary combination for EM, and so it has proved once again. Having reached tipping point the yen will often rally strongly as it has now and as it did in May 1997. This may or may not delay the impending EM implosion for a few weeks. Indeed the Thai Baht, the first domino to fall in the Asian crisis, briefly rallied strongly (vs the US$) in early June 1997, reassuring investors just ahead of its ultimate collapse.
There has never been any shadow of doubt in my mind that tapering = tightening, and I marvel that the Fed convinced anyone otherwise. A Fed tightening cycle inevitably plays a key role in triggering the next crisis (see below). Plus ca change, hey?
- 1970 Recession/Penn Central Railroad
- 1974 Recession/Franklin National Bank
- 1980 Recession/First Penn/Latin America
- 1984 Continental Illinois Bank
- 1987 Black Monday
- 1990 Recession/S&L and banking crisis
- 1997 Asian currency collapse/Russian default/LTCM
- 2007 The Great Recession/Collapse of almost the entire global financial system
- 2014 Emerging Market collapse/deflation/recession/another banking collapse etc., etc.?
Additionaly, we have now made it all too clear that there is no such thing as a market anymore - there is a carry trade, manifsted typically by the level of the USDJPY - which is the ultimate driver of all risk. It is this trade that Edwards warns will no longer work as it results directly in EM collapse, as can be seen most recently as the source of the EM crisis of 1997.
And while the bulk of the note focuses on Edwards' take of Andrew Lapthorne's comments which we summarized before (see Refuting The Biggest "Recovery" Lies In Four Simple Charts), his conclusion is worth highlighting as well:
But the inevitable has occurred and fundamentals have caught up with the markets as they always eventually do. The recent slide in US equity prices has been entirely consistent with the profits outlook Andrew has been flagging for some months (see chart below).
The market has at last awoken from the dream it hoped would last forever ? you must have had one of those dreams which you hope you can get back to if you fall asleep again quickly. The pungent smell of coffee has now overwhelmed the hallucinatory vapours contained in QE. Commodities snapped out of their trance some two years ago and could not find their way back into that same dream-like state. Now it is equities turn.
The dire profits situation will only get worse as EM implodes and waves of deflation flow from Asia to overwhelm the fragile situation in the US and Europe.
... the slump in the recent ISM data may be the ?straw in the wind? of what is to come. Certainly the three-month change of the leading indicator has now turned down sharply ? even before the recent ISM data has been incorporated. We watch the unfolding EM crisis with increasing trepidation because we know how this story ends. We have been here before.
And even if the Fed resumes massive QE at some point as the world melts down, and markets desperately attempt their return to the dream trance, they will instead find themselves locked into a Freddie Kruger-like nightmare in which phase 3 of this secular bear market takes equity valuations down to levels not seen for a generation.