"In Short Janet, It's Too Late" - Albert Edwards Calls It With These Seven Charts

Tyler Durden's picture

In the aftermath of the Fed's first rate hike, SocGen's famous skeptic and "Ice Age" deflationista, Albert Edwards, who formerly called Alan Greenspan an "economic war criminal", unloads on Yellen and says that not only is the Fed's hike too late, but that the "Yellen Fed will soon be treated with the same contempt the Greenspan Fed was in the aftermath of the 2008 financial crisis."

Cutting right to the chase, Edwards thinks the "Yellen Fed will go down in infamy as deliberately stoking up yet another massive financial bubble. But unlike the start of the last tightening cycle in 2004, this time the corporate bond market is already severely stressed and it may take just a tiny pin-prick to burst open the putrid excess."

To prove his point, Edwards shows the following chart which demonstrates the rampant bank credit growth unleashed by ZIRP, most of which has gone to fund stock buybacks as we showed in the past...

... and says that "in the wake of the 2001 recession, an extended period of corporate de-leveraging to unwind the excess of the tech bubble led the Fed to maintain loose monetary policy for far too long. By the time it eventually began to tighten, in June 2004, household debt growth rampant and eventually blew up the economy. This time around it will be no different, credit growth has already reached peak historical rates. In short Janet ?- It?s too late!"

He then attempts to answer what is perhaps the most important question: where in the business cycle is the US economy, for which he uses several charts, chief among which is the following which "nicely sums up the failure of the Fed?s strategy: the household savings ratio has stubbornly remained above 5% despite the Fed pumping household net wealth (which includes housing wealth) back up to all time highs (see chart below). The Fed would have hoped for a far larger decline in the ratio to boost GDP (savings ratio below is inverted).

He then shows a chart we have used on numerous occasions, perhaps the only chart which matters, this time in an iteration created by SocGen's Andrew Lapthorne, which "compares the quoted sector net debt (net of cash) explosion to profits. This is 100% attributable to the Fed's excessively loose monetary policy.  Bernanke et al still blame excess global, and especially Chinese, savings for fueling the 2004-8 boom and bust cycle, claiming there was nothing they could have done to stop it. Let's see who Yellen blames this time around!"

 

Edwards then focuses on a chart which we first showed one month ago, which very clearly shows that virtually every raised through debt has been used, over the past two decades to buyback socks.

 

But it's not just the use of debt-funds. The problem is that as debt built up, it did not create incremental cash flow, and as Edwards observes, key metrics such as EV/EBITDA show stock market valuations back to all time highs "and well in excess of PE measures." The take home: "it is very difficult to find any cheap stocks."

Edwards then goes on a tangent to explain the recent cardiac arrest of the junk bond market:

For those of us who have been warning for some time of the ever expanding bubble of US corporate debt, the recent problems in the corporate bond markets come as no surprise. There is a limit to how much degradation of corporate balance sheets bond investors are  prepared to tolerate. Hence the rapid widening out of junk bond spreads in the second half of last year was ultimately the result of the Fed's free money policies. Widening spreads were not just as many claimed merely due to problems within the energy sector. Spreads were also widening noticeably even if the energy sector was excluded.

Edwards, therefore, thinks the bond market is saying two things: "the party's over and bond investors who always tend to be more sober types, realize this and have headed for the exits whereas equity investors are so intoxicated they haven't realized that the music has stopped. Equity investors are still gyrating around the dance floor - just as in 1999 and 2007.

And the second thing the bond market is telling, is that "there is excess leverage in the US corporate sector, it doesn't help that both corporate profits and revenues are now falling."

The most visible way to see this, is by looking at nominal business sales and inventories which have been contracting all year as we have shown previously, however with sales sliding far worse than GDP-building inventories. And while Edwards amusingly notes that while the weakness was initially attributed to "cold weather", the "chilly data has not gone away, as a combination of rising unit labor costs and weak pricing power have led to a typical late cycle decline in profit margins." And what is scariest for US GDP is that as we predicted over the summer, with sales continuing to decline, the fragile US recovery now runs the risk of an end-cycle inventory liquidation.

 

But where the SocGen strategist is most damning is when discussing the problem at the core of the Fed, namely that in addition to its explicit employment and stable price mandates, "there has been some debate whether to make "financial stability" an explicit mandate. Some Fed governors such as Kocherlakota believe the Fed should only be concerned about financial stability to the extent that it impact the Fed's ability to reach its existing inflation and employment goals. And that is indeed the problem."

For rather than presiding over a sustainable recovery, as the myopic Fed would have us believe, we are unfortunately sitting on yet another recession-inducing, debt time bomb waiting to blow. This comes at a time when the Fed's own favoured measure of core inflation, the core PCE deflator, remains close to 1% (in contrast with the core CPI which has been driven up to 2% by rapid rental inflation).

The conclusion is pure poetry.

Outright deflation beckons in the next recession as a direct result of the Fed's negligently loose money policies and hence it will fail to meet their explicit dual mandate, let alone its "unwritten" financial stability target. I believe the Yellen Fed will soon be treated with the same contempt the Greenspan Fed was in the aftermath of the 2008 financial crisis. And they will deserve it.

Yes... but as long as the market goes up - helped in no small part from buying by all the central banks including the Fed- nobody cares, and anyone who dares to warn about the hopium content of the Koolaid is branded a nut. The only time anyone does care is when the Fed can no longer prop up the object of its overt and covert manipulation, asset prices. By then, however, it is by definition too late as it means control has been lost.

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Jason T's picture

HD, AZO just to name 2 that give justice to this analysis.  MCD .. list goes on and on.  

nope-1004's picture

Edwards is always a very good read and worth listening to.

NoDebt's picture

"Yeah, but the Fed would never do anything to harm stock prices."

I guess we'll find out if that's true now.  Me?  I'm feathering out.  Been a nice run, time to book some long term cap gains and sit on cash for a while, see how this shakes out.  Don't care much about missing out on another 5% upside.  More interested in missing the next 25% downside.

pods's picture

Was it over when the Germans bombed Pearl Harbor?!?!

lunaticfringe's picture

After the Japanese took Poland you mean?

BullyBearish's picture

BTFD has become STFR (Sell/Short the F&^king Rip)

 

Higher rates equals fewer buybacks

  • Keep in mind, says BAML chief investment strategist Michael Hartnett, that wider credit spreads combined with higher benchmark rates means less corporate bond issuance, which means less cash for companies to buy back their stock (you thought corporations bought back stock with cash sitting in the bank!).
  • "This marks an important turning point for the stock market," says Hartnett, noting wider credit spreads and undperformance of the stock-buyback theme have been correlated over the past few months. "We would thus take profits in any short-term bounce in stocks.”
Mark Mywords's picture
Mark Mywords (not verified) Dec 17, 2015 12:31 PM

Irrelevant and discredited: The Federal Reserve Bank of the United States of America.

Hitlery_4_Dictator's picture

How is too late, thye have a printing press and can buy all stocks?? Someone pleasee explain, why it's over. Serious question. 

arbwhore's picture

Its not over until confidence in the currency is gone. Parabolic phase yet to come.

PAWNMAN's picture

I'm in the believe it when I see it camp. The difference this time is that ALL major Central Banks are doing it simultaneously. Japan's incessant money printing hasnt resulted in the loss of faith in the Yen. They have fundamentally changed the game.

A82EBA's picture

well now with qe tapered and rates on the rise im not sure confidence will be fully lost, its like they went right up to the cliff edge then turned back. the unwind could take another 10 yrs. wish someone would explain why the math is not possible. i got a $30 discount on gold this morning, just stay the course.

actionjacksonbrownie's picture

Not only does the fed have a printing press, but they have a hidden balance sheet. They can print and buy as much as they deem necessary, and no one is able to discern how hard or in what direction they are leaning. The fed can do this with absolute impunity until confidence in fiat is lost, and we are no where near that stage - not even close. Hell, the fed buck is the most highly valued liquid asset on Earth! It will take many more decades before the general population (and the rest of the world) finally sees how intrinsically worthless fiat currency really is. Until then, enjoy the slow downward spiral into hellish poverty, because that is where we're going.

Life of Illusion's picture

 

FED to late when never let market clear debts and put on their balance sheet.

Seasmoke's picture

Don't worry Kashkari is coming to save us all.

Mr. Schmilkies's picture

Keep hiking Yellen, but don't forget QE4, 5, and 6 early next year to offset it. 

buzzsaw99's picture

she should have raised the ffr to 2% on her first day as chairperson and blamed the bubble on bernanke. now she owns the coming collapse and i doubt she has the big bernanke hairy ballz for a huge bailout so it's on bitchez.

maneco's picture

There will be massive accidents in the near future. Yesterday was D-Day for Janet & Co. https://youtu.be/v_5QBJx0Im8

Number 156's picture

I say let it crash and burn.

Theyve messed with interest rates so the priviledged TBTF peoeple can have their bad bets made good.
Now, theyve messed with the interest rates now for so long that the pain will be considerable.

Instead of letting the system work like its supposed to, theyve rigged it, and done so for so long now that they had no choice. They were damnned both ways to hell.

So let it crash.

Hitlery_4_Dictator's picture

Trust me they want just that, but they are not ready with the final FEMA camps and getting thier supplies in the right places yet, aka Jade Helm. They are almost ready though, don't worry

Number 156's picture

Well, if true that would be another sweet move. Probably stupid enough to do it too.
Christmas next year will suck, followed by a market wide fire sale with nobody to buy their crap. (commonly known as a Sudden Stop)

 

Sir John Bagot Glubb's picture

will be triggered by food shortages.............and food stamp cards not working......................

GRDguy's picture

If pointing out that banksters are "agents of The Great Red Dragon" is too biblical, how about "Satan's Angels?"

arbwhore's picture

Not yet. We need a parabolic phase wherein all the world's remaining capital is poured into US equities and the $. S&P 2500-3000 and USDX 120.

Kolchak's picture

"

 I believe the Yellen Fed will soon be treated with the same contempt the Greenspan Fed was in the aftermath of the 2008 financial crisis. And they will deserve it."

 

Whats that bonuses and fuckin raises, yeah that should be terrible for them.

buzzsaw99's picture

in spite of his millions gollum's getting old and it does not look good on him.

madcows's picture

But, if they had tightened last year, how would the corps have leveraged all that buyback money?!

forputin's picture

After FED increased intrest rate RUB has crashed even more! Now it's 71 RUB for 1 USD http://www.forexpf.ru/currency_usd.asp

Putin why do you let as to fuck so hard... we are dooomed!!! :(

moneybots's picture

"Bernanke et al still blame excess global, and especially Chinese, savings for fueling the 2004-8 boom and bust cycle, claiming there was nothing they could have done to stop it."

 

Bernanke = Pinnochio.  Greenspan took the lending standard to ZERO and bankers participated in massive mortgage fraud.

It had nothing to do with Chinese savings.

Greenspan WANTED a housing bubble and he got one.

hxc's picture

Fed cheerleader Krugman even said on national television that we should inflate a housing bubble to replace the nasdaq bubble. Fucking psycho

kaboomnomic's picture

Well.. First, you got clueless leader. Check!!

Second, you got clueless central bank.

Third, you got clueless economists.

Forth, you own the biggest casino of all time.

Ohhhh... so PERFECT combinations...!!

Uchtdorf's picture

Oh, it's a combination, alright. Everything that happens though is done on purpose. Notice how those "clueless" traitors never do anything that benefits the average guy. If they were just stupid, every once in a while, something would go my way.

Chris P's picture

"It's not over until the fat lady sings" I wonder what kind of voice Janet has?

moneybots's picture

"Yellen Fed will soon be treated with the same contempt the Greenspan Fed was in the aftermath of the 2008 financial crisis."

 

Yellen has been stuck with the mess Bernanke has created.

Barrack Chavez's picture

Everyone knew Bernanke created a horrible mess. Yellen was the only one stupid and arrogant enough to still want the job

JRobby's picture

They all belong to the same club

delivered's picture

AE is right and it should also be emphasized the Fed (as well as other CBs) have already lost control to the most basic of economic theories and ultimate force - the laws of supply and demand. The data at the start of the economic food chain clearly supports this as oil/energy, base materials/metals, shipping rates (BDI/SCFI), and heavy industry (think CAT) are all basically in an economic collapse from a pricing standpoint. Just far too much supply and weak to falling demand means the price should decrease, the basic concept of the law of supply and demand.

The world's CBs have attempted, through the use of exotic, toxic, and outright fraudulent paper mechanisms, to manipulate the real economy in an attempt to inflate their way out of the ultimate and core problem - too much debt and not enough income/cash flow to support the debt. If one thinks about it for just a second, its easy to see the CBs are doing the same thing a business would do to manage excessive debt loads and spur consumption. First up, reduce the cost of debt via lower interest rates. Check. Second, lengthen debt repayment terms. Check (think record length of auto loans, European countries issuing 50 year bonds/Spain I believe). Third, restructure debt terms and conditions via changing security position, priority, rights, etc. Check (think the ECB deals). Fourth, call on secondary repayment sources to repay the debt. Check (from bail-ins to negative interest rates to QE, all fall under this strategy). Finally and fifth, write-off debt that can't be repaid. The goal across the board is simple. Reduce debt service requirements!

The trend now is that the problems with the start of the economic food chain noted previously is no spilling over into the credit markets, first with HY/Junk and then eventually to IG and up the ladder it will go. Capital is now beginning to be priced based on economic fundamentals (i.e., can a company actually repay debt from cash flows, a rather novel concept) and the laws of supply and demand and not from CB policy. They created a monster problem of mal-investment that resulted in excess capital being invested in unsustainable long-term business models, unfortunately with excessive levels of debt. Now that the market is realizing that the debt can't be repaid, credit spreads, HY/junk rates, and even IG debt are all beginning to price credit using economic fundamentals and not CB steriod injected "fantasy rates". This is really no different than the tech start-up receiving a unicorn valuation based on hope and dream forecasts. Once the reality of the market sets in and people come to the conclusion that an actual revenue model is required to support valuations, the crash back to reality is very painful.

The only questions now are two fold. First, how quickly does the credit market repricing and liquidity issues spread to the balance of the economy? Second, what is the next segment of the economy to really start to feel the pain? Not sure about the first question but I suspect 2016 is going to be a very bumpy ride. As for the second question, transporation is already suffering with retail starting to come along for the ride (just too much inventory on the shelves with too few buyers so look for product dumps a plenty in 2016). One area I would watch closely is the auto industry as ZH has on numerous occassions noted the excessive level of inventory builds and channel stuffing in this sector. Further, with auto loans at record lenghts, the ability for customers to turnover into a new auto purchase with most likely a high level of negative equity in the car is going to negatively influence auto sales.

Equities will soon enough get the message but as usual, they are the last one to leave the party (and thus will have the worst hangover). Of course once equity gets the message combined with receding cash flow, the only way to improve performance, repay debt, and increase stock prices will be to reduce expenses. And number one of this list of expense reductions, employees (the easiest target). Or to quote Warden Norton from the Shawshank redemption, jobs will vanish "like a fart in the wind". 

fowlerja's picture

Janet....congratulations on your bold decision to raise the interest rate by .25%. You have scannned the economic future and decided the punch bowl needed adjusting....thus you went from 100% scotch to 95% scotch.  You can sure taste the difference! Not sure why anyone made a fuss about your decision...especially when they could have checked your background and found that your PhD thesis was..."She received her Ph.D. in economics from Yale University in 1971 for a thesis titled Employment, output and capital accumulation in an open economy: a disequilibrium approach."  

Anyone with a thesis like that surely knows when to raise and lower rates. Anyway congrats again...and have a great holiday season...

IProtectYou's picture

There is a limit to how much degradation of corporate balance sheets bond investors are  prepared to tolerate.

Considering Govts. sold  almost 3 trillion of bonds with a negative yield, I assume this limit is very high.