As the equity markets have suffered their worst performance ever to start a year, we’ve heard the familiar refrain from the chorus of sell-side analysts: Don’t panic, the economy is fine and the markets will recover. Among the few who are warning that things could get worse – indeed, much worse – is Albert Edwards.
Edwards spoke at Societe Generale’s annual global strategy conference in London on January 12. Edwards is the firm’s global strategist.
The underlying source of Edwards’ pessimism is the continued appreciation of the dollar. This has “crushed” the competitiveness of U.S. corporations – mimicking the 1997 Asian conference but on a global scale.
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In a recent note to Societe Generale’s clients, Edwards wrote that the U.S. just experienced a cyclical bull market within a secular bear market, and the bear market has not ended.
“If I am right,” Edwards wrote, “the S&P would fall to 550, a 75% decline from the recent 2100 peak.”
No thawing in the ice age
Edwards has been right over the long term. In 1996, he predicted the beginning of an “ice age,” during which equites would underperform bonds.
The chart below compares the returns of 10-year bonds to the S&P 500, including reinvestment of dividends and coupons, beginning in 1996:
Every time the returns look like they are about to converge — as was the case, for example, in 2007 — equities underperform and the ice age endures.
Edwards said that quantitative easing (QE) is driving the instability in the financial markets. As the U.S., Japan and Europe have used monetary policy to reduce interest rates, money is flowing to emerging markets (EM), commodities and fracking in search of higher yields.
“Now,” he said, “it is all turning bust.”
Europe is facing its own set of QE-induced problems. France, Edwards said, is the “real problem.” “I cannot conceive that only 10 years ago French unemployment was not only below Germany’s, but substantially below it,” he said. This is because unit labor costs are converging across Europe, except in Italy and France where, Edwards said, they are “far too high.” Nonetheless, Edwards said French equities might do well, even though economically things are looking very poor.