First confirmed permabull Jim O'Neill presented 10 "grizzles" why the bear market may be coming back, then Bob Janjuah reiterated his very bearish outlook on life, and, right on cue, here is Albert Edwards with his latest crucifixion of unwarranted bullish sentiment."As we head into a double-dip, the current technical correction will rapidly turn into a resumption of the structural bear market for stocks. We have not seen the worst yet." Perhaps BMO's recommendation for a zero equity weighting is spot on...
Over the past month David Rosenberg has been pounding the table on the signal being sent by the collapse in the ECRI leading indicator. It appears his message has not fallen on deaf ears.
From SocGen's Albert Edwards:
Frederic, one our US equity salespersons, is worried. He mailed me yesterday asking me about the steep downturn in the Economic Council Research Institute (ECRI) weekly leading indicator (see chart below). To quote “I find the acceleration seen since May pretty alarming, the ECRI never had such a pace, even in 2008 in the middle of the CDO explosion, when nobody had a clue if the financial system could hold!!”
Now the last time Frederic contacted me about this leading indicator was back in early 2009. I had spent most of the bear market pontificating that we should all learn the lessons from the Japanese bear market viz that in a post-bubble world the equity market and economic cycle would become much more synchronized. Hence it was much easier for an investor to time a tactical re-entry into equities during the Ice Age. One merely had to wait to buy when the leading indicators began to turn upwards.
So in early 2009 Frederic began calling me to point out the ECRI was indeed recovering and given what I had said, shouldn?t I be moving back into equities on a cyclical basis ?irrespective of whether the structural bear market was over or not? Good point Freddie. What did I do in the face of this clear buy signal I had so long been waiting for? I did absolutely nothing. It was a case of do as I say, rather than do as I do. Firm in the knowledge that the structural bear market had not fully played itself out, I managed to miss one of the biggest cyclical equity rallies on record. Do I deserve to be taken out by research management and publicly thrashed to within an inch of my miserable life? Yes I certainly do.
Of course, ECRI could well be ignored if it did not also match up perfectly with shifts in overall analyst sentiment. Which is precisely what it is doing:
Frederic'?s concern about the pace of decline in the ECRI goes to the crux of whether this is a technical correction in risk assets or a renewal of the bear market. It is worth noting that despite all the anxiety this year about Greece/Chinese liquidity et al, it took a non-farm payroll disappointment to produce the second biggest one-day decline in the Dow this year, last Friday. The cycle is key, and the leading indicators tell us there is a big slowdown on the way.
Hence I took particular note of the latest edition of Global Equity Market Arithmetic produced by my Equity Quant colleague Andrew Lapthorne. As well as lots of useful market stats, he carries regular updates of analysts? optimism ? defined as the percent of analyst EPS estimate changes that are upgrades. He notes a savage slide in optimism in recent weeks (see charts below). He even notes that the current lower level in optimism in the Pacific ex-Japan region is now consistent with declining profits!
As previously reported, we find the change in analyst optimism manages to lead some of the more well known leading indicators quite well (e.g. see chart below). This rapid rate of erosion is something investors ignore at their peril. We are watching this closely.
Albert's conclusion is that this is merely yet another factor reinforcing the beliefe that far more than a mere technical correction, the fundamentals are once again about to take over, and take the market far lower from current levels.
We highlighted recently that the equity market was ripe for a technical correction looking at an array of indicators (e.g., put/call and bull/bear ratios and percentage of stocks above the 50 day moving average). Most of they key technical indicators have now corrected (see chart below for example). It is perfectly plausible that we see some temporary consolidation here before the market resumes its downward march. What differentiates this correction and the one we saw in February is that the leading indicators are unwinding this time around. That should leave us sceptical that any rally will persist for long.
So far the market downturn has been characterized as primarily one driven by EUR weakness, with risky assets and FX correlating nearly one to one. Gradually, we expect this relationship to fully decouple as shaky and deteriorating US fundamentals once again become the primary driver of skepticism that the bear market rally is finally over. We also expect Edwards' note to not be the last bearish one we come across today.