Sheer poetic brilliance from the world's greatest realist, Soc Gen's Albert Edwards: "The current situation reminds me of mid 2007. Investors then were content to stick their heads into very deep sand and ignore the fact that The Great Unwind had clearly begun. But in August and September 2007, even though the wheels were clearly falling off the global economy, the S&P still managed to rally 15%! The recent reaction to data suggests the market is in a similar deluded state of mind. Yet again, equity investors refuse to accept they are now locked in a Vulcan death grip and are about to fall unconscious."
In fact, Albert Edwards and Alan Greenspan should get together in a cage match to the death. It is now well known that the former Fed governor was manipulating the stock market on a day to day basis, as his statement that "if the stock market continues higher it will do more to stimulate the economy than any other measure we have discussed here" makes it all too clear that the Fed does not care about inflation or unemployment but merely Dow 10,000 hat sales, and will do everything in its power, even if that means collaborating with Chicago hedge funds in dark pools, to get stocks to go up. Yet how long until investors finally realize that stocks are not only a lagging indicator but a manic-depressive one at that:
The notion that the equity market predicts anything has always struck me as ludicrous. In the 25 years I have been following the markets it seems clear to me that the equity market reacts to events rather than pre-empting them. We know from the Japanese Ice Age and indeed from the US 1930's experience, that in a post-bubble world the equity market merely follows the economic cycle. So to steal a march on the market, one should follow the leading indicators closely. These are variously pointing either to a hard landing or, at best, a decisive slowdown. In my view we are poised to slide back into another global recession: the data is slowing sharply but, just like Japan in its Ice Age, most still touchingly believe we are soft-landing. But before driving off a cliff to a hard (crash?) landing we might feel reassured when we pass a sign that reads Soft Landing and we can kid ourselves all is well.
So yes, the slump is coming and the catalyst will appear loud and clear when the next stage in the analyst downgrade game begins: note - everyone already took down their GDP estimates. Guess what comes next. And yes, those sky high gross profit margins that everyone is touting are a two-edged sword - corporate America has taken advantage of the good side, soon, however, the time to pay will come.
I read an interesting article recently noting the equity market typically does not begin to slump until just AFTER analysts begin to cut their 12m forward EPS estimates (for the life of me I can't remember where I read this, otherwise I would reference it). We have not quite reached this point. But with margins so high, any cyclical slowdown will crush productivity growth. Already in Q2, US productivity growth fell 1.8% - the steepest fall since Q3 2006. Hence, inevitably, unit labour costs have begun to rise QoQ. This trend will be exacerbated by recent more buoyant average hourly earnings seen in the last employment report. Whole economy profits are set for a 2007-like squeeze. And a sharp slide in analysts' optimism confirms we are right on the cusp of falling forward earnings (see chart below).
Edwards get downright hostile when discussing recent economic data out of US. We understand - the ever more acute manipulation of data by the BEA drones is getting infuriating. (bold below is Albert's)
August's rebound in the US manufacturing ISM was an even bigger surprise. This is a truly nonsensical piece of datum as it was totally at variance with the regional ISMs that come out in the weeks before. The ISM is made up of leading, coincident and lagging indicators. The leading indicators - new orders, unfilled orders and vendor deliveries - all fell and point to further severe weakness in the headline measure ahead (see chart above). It was the coincident and lagging indicators such as production, inventories and employment that drove up the headline number. Some of the regional subcomponents (eg Philadelphia Fed workweek) are SCREAMING that recession is imminent (see left hand chart below).
Lastly, Edwards discusses the feasibility of his S&P 450 target in light of a Fed that is resolute in never ever allowing stocks to fall again.
Indeed we know that a central plank of the unhinged policies being pursued by the Fed and other central banks is to use QE to deliberately target higher asset prices. Ben Bernanke in a recent Jackson Hole speech dressed this up as a "portfolio balance channel", but in reality we know from current and previous Fed Governors (most notably Alan Greenspan), that they view boosting equity and property prices as essential for boosting economic activity. Same old Fed with the same old ruinous policies. And by keeping equity and property prices higher, the US and UK Central Banks are still trying to cover up their contribution towards the ruination of American and British middle classes - (see GSW 21 January 2010, Theft! Were the US and UK central banks complicit in robbing the middle classes? - link). The Fed may indeed prevent equity prices from slumping with any QE2 announcement. But this sounds a familiar refrain at this point in the cycle. For is monetary easing in the form of QE that different from interest rate cuts in its ability to boost equity prices? Indeed announced rate cuts in previous downturns often did generate decent technical rallies. But in the absence of any imminent cyclical recovery, equity prices continue to slide lower (see chart below). The key for me is whether QE2 can revive the economic cycle, not equity prices temporarily.
And here is the kicker for all those expecting a massive stock surge on the imminet QE2 announcement:
Many of our clients think QE2 might give a temporary flip to the risk assets but that the subsequent failure to produce any cyclical impact will cause an extremely violent reaction as investors lose faith in QE as a policy tool and Central Banks in general.
Forget our suggestion about the Greenspan-Edwards deathmatch (aside from the obvious outcome) - we cede it to the SocGen dude preemptively:
If we plunge back into recession, do not place too much confidence in the Central Banks having control of events. As my colleague, Dylan Grice, said last week "let them keep pressing their buttons." Ultimately they cannot fool all of the investors, all of the time.