Why Albert Edwards Thinks "NOW Is The Time To Worry"

When back in February, we pointed out a disturbing and dramatic divergence in the delinquency and charge-off rates between America's thousands of small banks and the 100 or so biggest...

... we wondered if anyone would notice it. After all the implications were profound, and as TCW had previously noted, it "was America's smaller banks – those not in the Top 100 by asset size – that have experienced in just the recent months a surge in charge-off deterioration, which at 7.9% is on par with the last financial crisis!"

Well, just a few days later, the WSJ did, and overnight so did SocGen's Albert Edwards, who unlike the paper of record had a kind introduction to this critical inflection point in the economic data, if only for those banks which cater to the less affluent, more "regional" Americans:

I know some people don’t like the Zero Hedge (ZH) blog, but I certainly do –and not just for the confirmatory bias it gives me regarding own bearish views. ZH often flags up economic data and issues I would otherwise miss, ahead of the pack. Not much surprises me or shocks me nowadays, but I was truly gobsmacked by the surge in charge-offs and  delinquency rates on credit card loans made by smaller US banks (see chart above).

In the aforementioned WSJ article, Robert Hammer, chief executive of credit card industry consultant R.K. Hammer, says, “The small banks’ experience is simply a leading indicator of a downturn to come. In the run-up to the last recession losses accelerated for small banks before they did for big ones.”

And while we thank Albert for the kind words, the reason we once again remind readers of this particular data, is that as Edwards further notes, it is a key part of the puzzle suggesting that a recession - or maybe stagflation - is rapidly headed for the US economy, which is "about to reach a memorable milestone" as the US economic cycle is set to hit 106 months in April, making it the second longest in history, and would be the longest ever if there is no recession by the time Trump begins campaigning for his second term in the summer of 2019.

“Here, Edwards quotes Lance Roberts, who says that "It is certainly not surprising that after one of the longest cyclical bull markets in history individuals are ebullient about the long-term prospects of investing. The ongoing interventions by global central banks have led to T.T.I.D. (This Time Is Different) and T.I.N.A. (There Is No Alternative), which has become a pervasive and Pavlovian investor mindset. But therein lies the real story. The chart below shows every economic expansion going back to 1871 and the subsequent market decline. This chart should make one point very clear – this cycle will end.”

Of course it will, but when?

Commenting on this rhetorical question, Edwards notes that "clients always want to know if they should worry NOW?" His answer to that is "yes they should" as there are "very worrying signs that yet another Fed-inspired credit bubble is beginning to burst", and not just in the surge in small bank delinquencies.

My former colleague Paul Jackson puts some great charts on Twitter and is definitely worth following (his handle is @belgiandentists, or is the term ‘handle’ from CB radio and the Convoy film). Paul showed that it is not just credit card delinquencies that are on the rise – mortgage delinquencies are too (see chart below).

There are many other pre-recession/bubble-bursting signals emerging, one of which has been flagged by William White, former chief economist of the BIS, who warned that the current situation is as dangerous as 2008.

White, now at the OECD, believes successive economic recoveries have been so reliant on debt that interest rates cannot rise to prior cycle levels, and hence there is a downside bias in each successive cycle. In particular, the extreme monetary policy measures taken since 2008 have inflated yet another credit bubble. As the Fed now tries to normalise rates with an eye on the real economy, unemployment and inflation, it will find that the newly inflated credit system is unable to tolerate even moderate rises in rates.

A familiar concern here is that rising rates would destroy the countless number of "zombie companies" which only exist thanks to low interest rates. This was highlighted in a recent report by Moody’s, which "certainly seem concerned that although credit markets have shrugged off sky-high corporate debt levels, the Q1 slowdown in GDP and business sales may begin to re-engage the disturbing relationship below."

Another worry is the recent sharp weakening of the US (and European) economies in recent weeks...

... even as markets enter another confidence-crushing correction.

Once again the Fed has built up the illusion of economic prosperity on a mountain of debt, fuelled by monetary steroids that have inflated asset values way beyond their sustainable level. As markets begin to slide, this wealth is now being eviscerated as quickly as it was created, and it threatens this increasingly anaemic and very aged recovery.

And while his analysis is now slightly out of date - recall we showed earlier today that the US savings rate has actually grown to the highest since last August after hitting near all time lows recently as Americans slowed their spending, Edwards points out that the US Saving Ratio (SR) collapsed at the back end of last year to only 2½% (close to its all-time low), driven in large part by the stock market rally (see chart below - SR inverted).

My back of the envelope calculations (OK, I used a calculator) suggest that without the fall in the SR through 2017,  the 2.3% GDP growth recorded for 2017 would have been only 1.5%, the same as 2016. The risk is now, with the tide going out on the equity market that the SR jumps higher, growth flounders, and the iceberg of debt rips open the hull of this supposedly unsinkable economic ship. If you want to blame someone, blame the Fed. And I am sure that is exactly what President Trump will do when he loses patience and moves to remove their independent status.

Finally, speaking of the Fed, it is worth remembering that just as the Fed unleashed the (soon to be) second longest expansion in history with the help of trillions in liquidity injections and asset purchases, so it will be the Fed that will launch the next recession depression.

The Fed generally tightens rates until something breaks. David Rosenberg points out that since 1950 there have been 13 Fed tightening cycles, and 10 of them ended in recession (while the others have often ended in emerging market blow-ups, like the 1994 Mexican peso crisis). Surging delinquency and charge-off rates for smaller banks  suggest the breaking point for the economy may come sooner than the Fed and bulls expect.

Which brings us to Edwards' conclusion which is a welcome one for those who say the time to end the Fed is here, as the SocGen analyst believes that it will be Fed that is ended after the next crash:

This data merely reflects the illusion of prosperity. The markets are now sniffing out a rising stench from decaying debt. They say a fish rots from the head down. Unlike the 2008 financial crisis, this time I expect it is the Fed that will be held responsible for yet another debt crisis. Do not expect their independence to survive.

One can only hope.