When it comes to macroeconomic forecasts, one could not have been more spot on than SocGen's Albert Edwards, whose call of nearly two decades for a global deflationary "Ice Age", much to the chagrin of the "recoveristas", has proven absolutely accurate, now that one after another global region is succumbing to deflation. His other call for a collapse in global bond market yields has certainly been validated as well as we showed last week when we demonstrated that $3.6 trillion, or nearly a fifth of the global government bond market, is trading with negative yields.
Yet one place where Edwards's call for a bear market has so far failed to materialize is the one which over in he past 6 years has transformed from its traditional role of discounting the future and become the central planners' preferred policy vehicle of choice to preserve and boost investor and general public confidence: stocks.
It is therefore not surprising is Edwards' stern warning that the relentless stock market masquerade, manifesting itself in a virtually flat diagonal line from the March 2009 bottom, on the back of now every single developed central bank injecting direct liquidity into the market, is ending.
The bulk of our Ice Age thesis has now played out. One part though that hasn?'t is in the equity market, where I constantly see ridicule heaped upon our view that we are still locked in a secular valuation bear market that began in 2000 - with equities likely to fall below 2009 lows. I remain confident that the global equity markets will be ripped to smithereens in the next economic downturn which will, once again, show that the central banks have inflated another massive unstable financial bubble. But even without the coming ultimate equity denouement, any investor who, like us, has underweighted global equities since we made our (somewhat premature) call at the end of 1996 has outperformed - and at far lower volatility.
While Edwards wouldn't touch stocks, he still believes there is more room for upside in the 10Y government bond, although not on a longer-term basis, where the eventual even more aggressive QE that is coming will finally break the bond market, leading to runaway (hyper)inflation (remember: not one currency in history has failed due to hyperdeflation).
We remain overweight 10y+ government bonds because we believe there is one final shoe to drop - and a very large one at that! (Note that on a 5-10y view I believe government bonds will be a disastrous investment and that further rounds of much more aggressive QE will ultimately result in much higher inflation ? starting with Japan). But on a 1-2 year view I think there is ample room for global yields to fall further - led by the US.
And while Edwards' bearish stance on equities is hardly unexpected, one thing the SocGen strategist revealed which most certainly was not widespread public knowledge is that if one uses the inflation-measurement methodology of Europe, then not only is core CPI in the US below that of "deflationary" Europe, but is in fact negative!
The US deflationary predicament, which is hiding between the lines, is why Edwards maintains his "view that the market is far too convinced that the US is in the spring of its economic recovery, whereas I believe we could well be in the autumn. What matters though is not my view, but the overconfidence of investors together with the very rich equity valuations." The catalyst would be investor realization "that, despite the US having recently been the single engine of global growth, the US deflation threat is every bit as immediate as that in the eurozone."
The US CPI shelter component is made up of rent (7% of total CPI) and owner-occupier equivalent rent (OER, a massive 24% of the CPI). Now, when we exclude food and energy from the CPI we often hear people complain that we shouldn't as food and energy are real expenditures that cannot be avoided. In contrast, the OER is a totally made-up number which no homeowner actually pays! OER is meant to measure the implied rent they incur by living in their home rather than renting it out - economists debate its inclusion in the CPI. Typically OER mirrors actual rents which tend to lag house price inflation, which rose strongly in 2013 but is now slowing sharply. Hence OER inflation will probably slow too this year, revealing the underlying deflation threat. But whatever the whys and wherefores, the bottom line is simple - OER is not part of the eurozone CPI and to compare like-with-like we should exclude it. If we do, the yoy rate of core US CPI inflation is the same as in the eurozone.
But, perhaps more significantly, the 6m change in core US CPI inflation (using the eurozone definition) is actually already negative, unlike the eurozone series. Who then do you think has the bigger deflation problem ? the US or the eurozone?
Which sadly means that not only all those "whopping" job gains of the past 3 months will be promptly "seasonally-adjusted" away during the next major revision opportunity, but that all the talk of a rate hike at a time when the US has a worse deflation problem than the Eurozone, will quickly an quietly disappear.