The Dow Jones and S&P 500 are rallying of late, so many believe a market bottom has already been reached. Investors and traders have been looking for a market bottom for some time, but analysts are split on whether it will happen imminently or whether the coronavirus-driven economic downturn will last longer.
Societe General analysts believe the downturn is only just beginning. In fact, they argue that the global economy wasn't even on solid footing when the COVID-19 pandemic hit.
Certain economic policies are no longer unheard of
Last week in his Global Strategy Weekly report entitled "Transitioning from 'The Ice Age' to 'The Great Melt,'" Societe Generale analyst Albert Edwards said extreme policy actions that were previously unheard of are now being considered. He said those extreme policy actions are facing off with "the forces of Secular Stagnation and The Ice Age, which will ultimately give way to a new secular phase in financial markets."
Many economists and analysts thought central banks would run out of ammunition when the next economic crisis hit. However, Edwards never thought they would. He said the last decade has brought "the unthinkable" in central bank policies. Now policymakers are enacting full-scale monetization with budget deficits of 15% or more.
He believes the coronavirus pandemic has sped up the transition in monetary policies and made them less controversial.
"The previously unthinkable is not only being thought, it is being implemented," he wrote.
Doing the unthinkable
Edwards noted that former European Central Bank President Mario Draghi recently called on the public sector to permanently run much higher deficits. He also called for debt in the private sector to be canceled.
Former Bank of England Deputy Governor and Chief Economist Charlie Bean is calling for the central bank to buy government debt directly in the primary market. He added that just a few years ago, this would have been considered "heresy," but now it's being discussed openly.
He added that for now, central bank stimulus is pushing against "an immovable (recessionary) object." Although he believes it may be clear what will happen in the medium term, the big question now is where the market bottom will be.
Hope for a market bottom and V-shaped recovery
He added that many have been writing about how well extraordinary stimulus will be able to dig the world out of the ongoing collapse. He said the answer to that question depends on whether you believe the global economy was on firm footing before the coronavirus pandemic set in.
He classifies himself as firmly in the bear camp, saying that he believes "that the financial and economic conjuncture was so perilous at the time Covid-19 hit, that a prolonged economic slump is almost baked into the cake."
He also believes that 10-year U.S. Treasury yields will converge with German bunds at the lower bound of the long-term trading rage, seeing this as not only plausible but also "inevitable."
No market bottom yet
Edwards said the equity market peaked toward the end of February, and many bulls saw sudden declines of up to 20% "because of the extreme over-optimism and bullish positioning." He questions why some believe the bear market ended and a market bottom was reached toward the end of March with just a 35% decline from the highs.
He believes fear of missing out is what caused the fastest 20% rally on record. However, he also pointed out that every bear market has fear-of-missing-out rallies "that suck investors back in" until the new motto becomes "selling on rallies."
The Societe Generale analyst has long believed the S&P 500 would retest the low of 666 seen in March 2009. That would be consistent with long-term support of the Dow Jones Industrial Average at about 6,000. That would represent an 80% decline from the 29,500 intra-day peak seen in February.
Crisis in the eurozone
Edwards believes most don't understand how "explosive" the political tension in the eurozone has become. He describes the economic stagnation that's been going on as "semi-permanent." He said Italy was angry by the lack of assistance with the refugee crisis, and now the pandemic has push Italy and other countries in the south "over the edge."
"The political rifts are now stretched almost to breaking point," he explained. "If the more fiscally austere northern eurozone nations do not allow euro-denominated coronabonds to be issued in a Marshall Plan-type rescue of Italy and Spain, then… the northern states will be outvoted on the ECB as they were in the latter stages of President Draghi's tenure when QE was restarted."
That resulted in Germans resigning from the ECB council, and if there's another Latin coup at the central bank, he expects an even larger backlash. He describes the current political situation as "an existential crisis for the eurozone."
Why the U.S. dollar must be weakened
Edwards also addressed the strong U.S. dollar. He noted that President Trump hasn't addressed the issue recently because he has been focused on the coronavirus pandemic. However, he argues that the U.S. can't tolerate importing deflation from other countries by keeping the dollar strong.
Many have written about the ongoing shortage in the U.S. dollar, and that may be exacerbating the recent increase. However, he adds that the markets are again underestimating the currency's increase by focusing on the trade-weighted dollar index.
Tracking the dollar against a wider basket of currencies, it has skyrocketed this year. If the Korean won enters freefall and triggers a similar fall in the renminbi, he believes attention will be turned back to currencies. He also predicts that President Trump will instruct the Federal Reserve to drive down the dollar with "unlimited FX intervention if necessary." He added that the increase in the dollar "cannot be tolerated any longer."