We have closely followed the work of SocGen's under-appreciated Albert Edwards and Andrew Lapthorne for years for one simple reason: they have been right all along, however as a result of ever more aggressive and extensive central bank interventions, the mean reversion that should have happened years ago, keeps getting postponed, assuring that when it does finally happen the outcome will be epic. That time may be approaching.
As Lapthone observes in his latest note, "global equity markets suffered their steepest weekly decline since early September, with the
MSCI World falling 3.4%. This latest decline leaves global equities down 4.2% for the year , and therefore underperforming most major government 10 year bond markets, which continue to stick in positive territory year-to-date. In local currency the, Eurozone has suffered more than most during the recent sell-off with the likes of Germany’s DAX down almost 10% since the beginning of December and France’s CAC 40 off by over 8%."
And while the topic du jour is the high yield melt up it was only a week ago when everyone was talking about the ECB's policy mistake and communication failure, which wiped out months of gains across European markets, not to mention trillions in market cap, in the span of milliseconds. Not only that, but in a rerun of the pre-September rate hike, China triumphantly announced that should the Fed hike, the PBOC will slam the Yuan not only against the dollar, but against all the currencies that make up its latest valuation basket, assuring even more aggressive devaluation in the coming weeks:
Little wonder Eurozone investors are concerned. For not only did the ECB disappointment lead to a euro rebound, but last week, and most significantly, China fully embraced the global ‘currency war’. The renminbi has now fallen by 5% versus the euro since the beginning of the month, and to demonstrate they were not going to stand idly by whilst almost everyone else devalues, the Chinese authorities started publishing a trade weighted yuan index to emphasise how they are simply trying to keep pace with devaluations seen elsewhere.
But back to the topic we have been covering for years, namely the illiquidity of the credit market, which came to a head when not one, not two but three funds have announced they are liquidating and/or gating as a result of the collapse in the junk bonds market.
Corporate credit markets are now at the forefront of investors’ mind. We have long highlighted the remarkable amount of debt being built up on corporate balances sheets, and market participants have fretted for some time about secondary market liquidity in credit
markets. These issues were bought to a head last week with the halting of withdrawals at a major credit fund. Junk bond ETFs (HYG), which were already struggling, experienced huge volumes and their worst weekly decline (-3.8%) since August 2011.
As SocGen observes, there is a simple solution to the paralysis strangling bond funds: cheaper valuations, which means lower prices, which means wholesale selling, which means contagion across asset classes... which means failure for the Fed's primary and only mandate.
The solution to uncertainty is cheaper valuations. If problems are priced in, investors can afford to look through near terms concerns and focus on the longer term. Worryingly, we have exactly the opposite situation today. Average stock valuations are close to historical highs – so we have lots of risk and little in the way of valuation cushion.
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Lapthorne's sarcastic conclusion is, not surprisingly, the same one we have presented repeatedly over the past several months:
"Time for a US rate rise then?"
Because soaking up anywhere between $800 billion [14] and $2.4 trillion (assuming a 75 bps rate hike cycle) in liquidity is precisely what this "market" needs?
