Albert Edwards, the Societe Generale analyst and faithful permabear, sees some vindication for his pessimistic outlook in the market’s recent downturn and scrambling emerging markets.

“Our warnings throughout last year that an unravelling of emerging markets (EM) was the final tweet of the canary in the coal mine have still not been taken on board,” warns Edwards. “The ongoing emerging market debacle will be less contained than sub-prime ultimately proved to be.”

Similarities with the 1997 Asian currency collapse

He sees deep similarities between the current financial environment (strong dollar, weak yen, tightening Fed policy) and believes that the emerging market weakness we are currently seeing is just the beginning of a new emerging market crisis. In 1997 the yen and Thai baht even rallied before the currencies collapsed, just as the yen is rallying now.

dollar v yen v thai 1997 Emerging Market

The potential for contagion in emerging markets comes as investors are realizing that DM fundamentals do in fact matter, and the S&P 500 (INDEXSP:.INX) has been dropping for a few weeks now.

“The deteriorating profits situation has been apparent to us for some time and has made odd bedfellows with an equity market incapable of clear thought. It is as if equity investors have been sent into a calming sleep after inhaling the sweet aroma of QE,” writes Edwards. “The pungent smell of coffee has now overwhelmed the hallucinatory vapors contained in QE. Commodities snapped out of their trance some two years ago and could not find their way back into that same dream-like state. Now it is equities’ turn.”

Emerging market: EPS growth flat by some measures

EPS growth has been weak in DM and negative in emerging market, but the situation is worse if you look at MSCI reported earnings instead of IBES pro forma numbers (what Edwards calls made up numbers). By this measure profit growth is close to zero.

“Even these MSCI figures have been flattered by a reduction in the share count plus lower interest rates and tax charges,” he writes. “At an aggregate level, most profit growth is the result of astute financial engineering rather than improving cash flow – yet another sign of a tired, long in the tooth, profit cycle.”

EM v DM yoy EPS growth 0214 Emerging Market

operating v proforma profits 0214 Emerging Market

Edwards always predicts the worst, so his forecasts have to be taken with a grain of salt, but they are still taken very seriously by people in the industry (he regularly fills the room when he gives talks). But now that even the bulls are taking notice of EM weakness and stagnant DM profits, problems Edwards has been harping about for a while now, his outlook could find more traction.