Societe Generale global strategy researcher Albert Edwards has been given a “frosty reception” for speaking out on central bank policy before, he notes in a September 7 research piece. But exactly what he warned about — a central bank induced “Ice Age” — is already occurring, he says. This is in part witnessed by an investing mantra that has as its value thesis “there is no alternative” to investing in overvalued stocks.
Buying stocks at sky-high price / earnings ratios: “What a mistake this will turn out to be”
Stocks are, by all accounts, expensive. After high-end asset prices across the board have been “inflated by super-loose monetary policy,” there is an emerging relative value thought.
The only argument for paying through the nose for high price earnings multiples, the one currently being peddled, is that other asset prices are more over-valued than stocks.
“Bonds (both corporate and government) and property are seen by most investors as even more ludicrously expensive than equities,” Edwards writes, pointing to the neighbor that always has to impress others on a relative basis. “The current justification for buying equities when they are so expensive is that other asset classes (especially government bonds) are even more grotesquely expensive and so ‘there is no alternative’ (Tina).”
Stocks and bond prices have for many years anchored a value correlation. Edwards notes this historic point in time through the yield defining value framework:
Talk of Greenspan reminds me of the so-called Fed Model of equity valuations avidly promoted during his tenure (see chart below). The bond/equity earnings yield ratio was a staple tool for all equity strategists in the 1980s and 90s. It acted as a buy signal for equities when the ratio began to sink below 1.0. This was always suspect thinking and when we put the Ice Age thesis together in late 1996 we predicted that this ratio would fall below 0.8 and then fall and fall and then fall some more just as it did in Japan in the 1990s. Yet the current justification for buying equities when they are so expensive is that other asset classes (especially government bonds) are even more grotesquely expensive and so ‘there is no alternative’ (Tina). What a mistake this will turn out to be.
Albert Edwards -“Nose-bleed valuations” caused by “central bank money printing” won’t end well
Albert Edwards is not known for holding back his views – which in part is the reason for his popularity.
In regards to current markets, Albert Edwards observes a common refrain among those whose voices are unconstrained. “Asset prices, including property, are at nose-bleed valuations because of his central bank money printing,” he wrote, pointing to “irresponsible” talk from Bank of England Chief Economist Andrew Haldane.
Central banks have been waging a war on savers, pushing them into riskier equity investments. Haldane, in asserting that real estate, “property,” is likely to be a better investment than pensions, is showing he does not recognize a bubble. ”Property” has risen significantly in value by numerous metrics, including rental costs and housing as a percentage of average people’s budgets, Edwards notes with a degree of outrage. Stocks have yet to catch property assets in the degree to which they are overvalued. Central bankers, now thinking of engaging in stock buying in the ECB, are engaging in what might be throwing gasoline on a fire.
What a mistake this will turn out to be.
Albert Edwards given “frosty reception” as his thesis is “the Fed Model, so widely adhered to by the market, would break down”
Albert Edwards is not an analyst prone to hyperbole, even though he does have an “Ice Age” theory involving central bank monetary distortion.
It’s almost hard not to laugh just a little bit when the key to that thesis is unveiled. “A key plank in our Ice Age thesis was that the Fed Model, so widely adhered to by the market, would break down.” The fact that he speaks this so clearly is bold and one can only imagine the constipated looks on central bankers as they listened. Edwards says he received a “frosty reception!” for engaging in a free exchange of ideas:
We pointed out at the end of 1996 that the long bull market had indeed seen a tight relationship between equity and bond yields, which had been falling in tandem since 1982. Throughout that time (and indeed until the final end of the long bull market in 2001), equity returns were dominated by multiple expansion, primarily driven by lower bond yields. The long bull market phase was a mirror image of what we called the dismal years, where between 1965-1982 equity and bond yields rose in tandem and the Dow went precisely nowhere in nominal terms for 17 years.
Edwards notes he was accurate on the general concept, just a little off on the timing. Much like Jeffery Gundlach saying the red line in the debt sand will take longer to arrive but once it does market will move quick, Edwards considers core valuation models that are as if we are living in the matrix:
Our Ice Age thesis in 1996 called for an end of the long bull market? financial era and that we would enter the mirror image of the 1950-1965 period. We were, as usual, too early and the ?long bull market? and positive correlation between equity and bond yields continued until the end of 2000. But what we expected to occur did occur eventually and from 2000 equity and bond yields de-coupled and equity yields rose (PEs fell) despite bond yields and interest rates continuing to decline. It as indeed a mirror image of the 1950-1965 period, dubbed the culting of equities. The so-called Fed Model was finally broken.
“Finally broken” almost sounds a tone of relief as market distortions can be hidden over long periods. Edwards goes on to look at the bursting of the equity bubble in Japan, noting that it was predictable. When asset values get pushed to “unhealthy valuations” there is but one reaction, and it is normally not pretty. “Most investors are currently neglecting the longer-term context of this secular bear market,” he wrote, then reflecting on the notion that unrealistic stock valuations are the only option. “Relying on Tina will prove disastrous.”