Albert Edwards: The Trigger For The Next Market Correction

Authored by Robert Huebscher via Advisor Perspectives,

Fear of overvaluation – particularly for U.S. equities – has driven far too many investors to miss the strong bull market. For market bears to be proven right, according to Albert Edwards, it will take one or more of several triggers.

Edwards is the global strategist for Societe Generale and is based in London. He spoke at his firm’s annual investment conference in London on July 9. A copy of his slides, as well as those from his colleague Andrew Lapthorne’s presentation, can be found below.

Edwards is not known for providing upbeat forecasts, but he said at the outset that he is not as bearish as usual. “I understand the competitive pressure to participate,” he said, “despite that fact this will go horribly, badly wrong.”

In 1996, Edwards forecast an “ice age” during which bonds would outperform stocks. He based this on his experience observing the Japanese economy, predicting that equity yields would rise as their prices fell, while bond yields would decline.

He noted that the U.S. equity market peaked in 2000, just as Japan did in 1989, and that U.S. stocks are still in a secular downtrend based on cash-flow yield. Edwards said the same thing happened in Japan and it continued for 10 years.

“The ice age is still intact,” he said.

The fate of the bull market

Do valuations still matter? Edwards said the U.S. forward P/E ratio is at a “considerably and extremely unusually high level,” higher than Europe and Japan. It’s not just the FANGS and technology stocks, he said. Using data from Grantham Mayo van Otterloo (GMO), he showed that the Shiller CAPE is not very dependent on the sector composition of the market, which accounts for only a small portion of the gap relative to historical levels.

Investor sentiment was missing a year or 18 months ago, he said, but now that data depicts “full-on bulls.” Using data from the American Association of Individual Investors, he showed that retail exposure is 75% in stocks (based on the ratio relative to cash) and at historically high levels. Data from Investors Intelligence shows that professional advisors are as bullish as prior to the 1987 crash, Edwards said.

“Essentially everyone has decided valuations don’t matter,” Edwards said. “But they do.”

He said the run-up to the 1987 crash was similar to the last few years. At that time, the bond yield started to rise following a period of rapidly increasing valuations. Oil had fallen but the economy recovered and was very strong, according to Edwards. “It looked very vibrant,” he said, “yet the market collapsed.”

What happened? Edwards said the dollar was falling and bond rates rose in response. The Bundesbank raised interest rates instead of helping to stabilize the dollar. The market feared the dollar would plunge and the Fed would have to raise rates, he said, triggering a recession. But market valuations didn’t support a recession.

Such a recession could be the trigger for a market pullback, he said, “or even just the fear of one.”

Another trigger could be the bond market. Two-year Treasury yields are greater than U.S. dividend yields, which he said is threatening equity valuations.

The yield curve is flattening, he said, but the market is still not expecting aggressive Fed tightening. One risk, he said, is that the yield curve flattens further along with a higher 10-year yield.

Yet a third trigger could be inflation and monetary policy. Edwards admitted he and the consensus were wrong about the bullish call on the dollar a year ago. Now the consensus is bearish about the dollar and bullish about the euro, he said.

“The Fed is composed of cowards,” he said. Since the taper tantrum in May 2013, it has gone out of its way to persuade the market that Fed funds rate will be less than 3%, according to Edwards. That makes it difficult for the dollar to rally. Every time it raises rates it goes out of its way to reassure markets. Ironically, despite rate hikes, he said, according to data from the Atlanta Fed, financial conditions are easier than prior to those hikes.

On a secular basis, he said the U.S. is in deflation, “but cyclically inflation will pick up.” Inflation could be a trigger, according to Edwards. Data from the New York Fed suggests core CPI could pick up and Edwards said this could surprise investors.

“Wage inflation was the dog that did not bark,” Edwards said, since it decelerated last year. This has been very reassuring for the market, he said, making it hard for the dollar to rally. The reason for the sluggishness in wage inflation, according to Edwards, is the persistently high level of potentially employable workers, despite the low published unemployment rate. But, he said, wage inflation could pick up.

A positive outlook for Japan

Amid his fears of a market correction, Edwards offered a positive outlook for Japan.

A big surprise has been wage inflation in Japan, he said, which has been stuck at 0.5% for two and a half years, despite a much tighter labor market than the U.S. “Japan had done fantastic things,” he said, “like getting women into the workforce – the one part of Abe’s policies that did work.”

Nominal income growth nominal is about 2%, he said, despite slow wage growth. Consumption has been running way ahead of income, unlike in the U.S., according to Edwards.

“There is a real case that consumption growth in Japan will accelerate very rapidly,” he said. Its GDP growth is at 2% and could increase, he said, which would be a surprise to the markets.

“Profits are rising as is the stock market,” Edwards said.

The big macro disappointment has been the Bank of Japan’s (BoJ’s) failure to hit its inflation target. Inflation is picking up everywhere else in the world, he said. But due to the BoJ pinning rates at zero, if inflation increases, real rates will decline and consumption will increase further.

Of all the central banks, he said Japan and Switzerland have been most aggressive. The BoJ’s balance sheet has already started to decline, he said, indicating that it is stepping away from its purchases of 10-year Japanese government bonds.

“A lot of major trends start with Japan,” Edwards said. “This could be very significant.”

But if the BoJ tightens, he said the yen could strengthen instead of its recent weakening.

“If you are looking for surprises and shocks that trigger a great unwind,” Edwards said, “it could be Japan tightening.”

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Full Slide Pack:

Comments

P.K.Snosage Tue, 01/16/2018 - 12:55 Permalink

"Essentially everyone has decided valuations don’t matter,."

This of course, is incorrect, most people trading the market do not know what valuations are.

coast1 Tue, 01/16/2018 - 12:56 Permalink

all i got me is some bitcoin :-(  I only put in $500, with a loss of $150..Probably should bow out of the crypto tho..This stuff about electricity and china banning it etc, crypto may work for a fedcoin, who knows

Really glad I held on to my silver tho...

a slam on gold today...Kinda thinking they did not want 1350, some say 1350 would be a gold break out.

truthalwayswinsout Tue, 01/16/2018 - 13:16 Permalink

We are in the most dangerous environment anyone has faced in the past 1,000 years. What you have is an artificial environment that has been created by a small group of central bankers. In terms you can understand, Bernie Madoff might as well be running everything.

Everything will chug along despite overcapacity in every industry by at least 240%. And one day, just as it did with Bernie, it will collapse and fall apart. When it does there will be no one who can save it.

Most banks will disappear overnight and what you will see is many of the officials who created this mess, disappearing overseas in the hope that the firing squads will not find out where they are hiding.

A reset under such conditions will be terrible and history setting but it has to happen.

What will trigger it? Who knows. But I do know which assets will be most valuable and that will be U.S. Treasuries and U.S. dollars in your hands and in your mattress. Gold, silver, bitcoins etc. etc. and many stocks and foreign currencies will implode and disappear.  The best strategy is to buy long term nonredeemable treasury coupons and hold them in your hands or at Treasury Direct. When interest rates go negative they will be worth a lot of money. Any buy when the 30 year goes above 3% is a gift.

For the gold and silver bugs, buying it at $200 and $7 will be the buy of a lifetime so be patient and wait for the fall.

 

 

apberusdisvet Tue, 01/16/2018 - 13:20 Permalink

 

They have to engineer a collapse before the midterms; 1) to blame it on the GOP and Trump 2) to gain house and senate seats for impeachment.

Any other time scenario wouldn't make any sense.

wmbz Tue, 01/16/2018 - 13:36 Permalink

"Val-u-a-tions"

No we do not care about or know who Val is.

Seriously is this guy kidding me? Since when, go back now, and tell me when valuations really did matter?

nuerocaster Tue, 01/16/2018 - 13:55 Permalink

The US has been by far the world's largest tax haven, political haven, scared money of any kind haven for a couple of centuries. Most of the world is running scared, circling the drain, or in the toilet.

The Swiss and now Canadians are starting to turn away business. Everyone going to pile into Chile?

No one knows the endgame. Official stats mean little.

How can all the pundits ignore the elephant herds? Oh wait there's no money in it for them? They couldn't get honest jobs laundering drug money or political bag men?

CatInTheHat Tue, 01/16/2018 - 14:03 Permalink

Get rid of us before collapse. Hence speeding straight to war.

Can't catch these asshats when they're all safe and sound in their luxury bunkers.

According to Deagal.com the prediction of the US population by 2025 will be 54 million. 

So 3/4 of the US is gone is either eating one another due to starvation or nuclear war. 

We are STOOOOPID. US government corruption in the largest transfer of wealth in the US via trillion dollars war package and the tax heist.

 

The parasites are done with their host. 

Time to kill it off.

Endgame Napoleon Herdee Tue, 01/16/2018 - 14:53 Permalink

Oh, everything is great. We supposedly have more women in the workforce, when they are not leaving work A LOT in crony gangs of back-watching absentee employees. It nonetheless solves every economic problem, especially when you give the moms lots of freebies from government for having sex and reproducing. RepubliCONs have doubled the child-tax-credit welfare here in America, giving frequently absentee moms in workplaces dominated by 98% childbearing-aged moms even more extra money from government in their paycheck to spend on tattoos and beach trips with boyfriends. Onward fiscally conservative Republicans. Onward to the next social-engineering solution: paid family leave to add even more womb-productivity income to the subsidized housing, free food, electricity assistance, nearly free daycare and child tax credits up to $6,444 to reward moms for working part time. Never mind the fact that many people lack spousal income and need for jobs to pay enough — and have enough hours — to cover all household bills without layer after layer of pay from government for sex and reproduction. 

In reply to by Herdee

Let it Go Tue, 01/16/2018 - 21:37 Permalink

The myth promoted by the central banks that a major currency cannot fail is accepted as fact by many people however, the rapid demise of either the yen or the euro is all that will be needed to reveal the truth. When a major currency fails it will remind people everywhere that our system of fiat money is held together only by faith in the system and a prayer.

Japan's public debt, which stands at around 250% of its GDP is the highest in the industrialized world. In the future, Japan's debt can only be addressed by printing more money and debasing the yen. The article below explores how when Japan crumbles it will be felt across the world.

  http://The Yen And Its Failure To Fail.html