Over the years, Socgen's Albert Edwards has repeatedly expressed his skepticism of both the economy and the market (the longest US equity "bull market" since 1945) both propped up by generous central banks injecting liquidity by the tens of trillions (at this point nobody really knows the number now that the 'black box' that is China has entered the global "plunge protection" game) and yet never did he have as "conclusive" a call as he does today. As the following note reveals, when looking at one particular indicator, Edwards is now convinced: 'we are now in a bear market."
First, Edwards looks east, where he finds nothing short of China's central bank succumbing to the "wealth effect" preservation pressures of its western peers:
After holding firm last weekend and resisting pressure to give the market what it wanted namely a cut in interest rates and the reserve requirement ratio - the PBoC caved in, unable to endure the riot in the equity markets. In giving the markets what they want China is indeed acting like a fully paid up member of the international financial community. I am not thinking here about freeing up their capital account and allowing the renminbi to be more market determined. I?m thinking instead of China?s replicating the failed US policies of ramping up the equity market to boost economic growth, only to then open the monetary flood gates as equity investors turn nasty.
We disagree modestly with this assessment because as we described first on Tuesday [11], the RRR-cut had much more to do with unlocking $100 billion in much needed funding so that China could continue to intervene in the FX market by dumping a comparable amount of US Treasurys since its August 11 devaluation, something which as we reported earlier today [12], China itself has also now admitted. But the reason why we do agree, is that while the RRR-cut may have had other "uses of funds", today's dramatic intervention by the PBOC in both the stock market, leading to a 5.5% surge in the last hour of trading, as well as a dramatic intervention in the FX market, it is quite clear that the PBOC will do everything in its power once again to prevent any market drops.
Edwards, then goes on to observe something which is sure to anger the Keynesians and monetarists out there: no matter how many trillions central banks inject, they will never replace, or override, the most fundamental thing about the economy: the business cycle.
Despite deflation fears washing westward and US implied inflation expectations diving to levels not seen since the 2008 Great Recession, there remains a touching faith that the US is resilient enough to withstand further renminbi devaluation. And if it isn?t, why worry anyway, because QE4 will be around the corner. But let me be as clear as I can: the US authorities CANNOT eliminate the business cycle, however many QE helicopters they send up. The idea that developed economies will decouple from emerging market turmoil is as ridiculous as was the reverse in the first half of 2008. Remember EM and commodities had then de-coupled from the west?s woes?until they too also crashed.
Which brings us to the key point - the state of the market, and why for Edwards the signal is already very clear - the bear market has arrived:
Although I am a bear of very little brain one thing I have learned is that most investors only realise the economy is in a recession well after it has begun. The same is true of an equity bear market. We need help before it is too late to react. Hence when Andrew Lapthorne shows that one of his key predictors of a bear market registers a 99.7% probability that we are already in a bear market, there might still be time to act!
[13]
... one feature of the market ?internals? in recent months has been the incredibly strong performance of high quality stocks (as defined by a variety of mainly balance sheet measures). This strength is now leading to price momentum and quality strategies becoming closely linked, with a 90% correlation (see chart below). Quality is now essentially price momentum and history tells us when these two strategies collide the omens are not good as it is a phenomena associated with equity bear markets. This becomes even more evident when we plug this data into one of our six bear market indicators, which now shows a 99.7% probability we are in a bear market.
[14]
So if we are then what? "In a secular bear market being wedded to hope destroys portfolios as the bear slashes to ribbons the hard-fought gains of the previous bull market. Gains that have taken years to accumulate are gone in months."
Ah yes, but not before central banks, which as Albert also correctly implies, are all in do everything in their power to prevent even the most modest market drop, because if there is anything first Bullard's comments in October, and then NY Fed president Bill Dudley' [15]s yesterday have shown, is that for the Fed none of the economic data actually matters - the only thing that does is the S&P500, and worse: even a modest 10% market correction is enough to lay total destruction to the Fed's best laid plans of an "imminent" rate hike, and even hint at QE4.
At the end of the day, this will be the most epic fight between what little "free market" forces are left, and the biggest and coordinated printing fest ever witnessed in modern economic history. While the ultimate outcome is clear to all, it is the process how we get there that everyone is fasctinated with. Our guess? First the central banks will take out all the bears, then take out all the bulls, until finally just the HFTs algos are left trading with themselves, in a "market" where the only signal is whether other algos are buying, or - Fed forbid - selling.
