Wednesday, February 24, 2010

Société Générale's Albert Edwards: "Stocks Face ‘Ice Age’ Drop as Indicators Peak..." Euro to $1.25; We're all Doomed

A threefer. The headline story is from Bloomberg, February 19:
Stocks are poised to tumble as gauges of the economic outlook in the U.S. and China have peaked, according to Societe Generale SA’s Albert Edwards.

The CHART OF THE DAY shows the Economic Cycle Research Institute’s weekly index of leading indicators for U.S. growth topped out on Jan. 15 and the Organization for Economic Cooperation and Development’s monthly gauge of measures for China peaked in October, according to Edwards.

High-points in the indexes for the U.S. and China, the world’s biggest and third-largest economies, foreshadowed the stock market selloff that began in October 2007 and sent the MSCI AC World Index down as much as 60 percent in 16 months. The China gauge bottomed in November 2008 and the U.S. index on March 6, before the rally in stocks that began on March 9, 2009.

“We monitor a variety of such indicators and until recently they have all been giving an unambiguous green light to participate in risk assets,” Edwards, Societe Generale’s global strategist in London, wrote in a research report today. “That has now changed.”>>>MORE

Two from ZeroHedge. First up (Feb. 19) the long version of the above:

Timing The Exit As Competitve Devaluation Looms; Is The Euro 25% Overvalued? More Thoughts From Albert Edwards

Soc Gen's Albert Edwards, who has never been shy about his cautious stance on equities, has released another report taking his cautionary posture to the next degree. This ties in perfectly with earlier observations by David Rosenberg which unmask the market for the jittery, volatile, headline-driven knee-jerk automaton it has become. Also, Edwards provides a response to readers who are confused by the strategist's endorsement of Richard Koo's mantra of fiscal stimulus as pertains to both Japan and the US. Somewhat tying it all together is the argument that the euro has yet to experience a 25% drop from current levels. That expectation makes the Morgan Stanley euro target of $1.25 seem timid by comparison. Yet in a world of competitive devaluation, as Albert Edwards points out, "it is the nation that devalues last which suffers the deepest deflation." We are confident that Ben Bernanke is all too aware of this mantra.

First, Edwards focuses on leading indicators and what "leading" implications their recent top may have for markets.

In a post-bubble Ice Age world, equity investors have to watch the cycle far more closely than before. One of the key lessons from Japan was that prior to their bubble bursting, equity valuations were dominated by movements in bond yields and hence there was only a very loose relationship between equities and the economic cycle.

But after the bubble burst and as The Ice Age unfolded, the close positive correlation between bond and equity yields broke down as equities suffered secular de-rating - driven by 1) the unwinding of unrealistic market-wide long-term earnings expectations in a low inflation world, and 2) a rise in the cyclical risk premium, as Japan?s own version of The Great Moderation gave way to highly volatile economic cycles.

Japan enjoyed some impressive 50% equity market rallies during their lost decade, driven by strong policy induced cyclical recovery. The secret was to exit as the cycle started to top out as this preceded the equity market dropping to new lows.

Early last year the safe re-entry back into risk assets was signalled by a clear upturn in leading indicators. So too now should investors be concerned that the leading indicators are topping out. The recovery in the leading indicator for China seemed to precede that of the composite for the OECD and similarly China has now topped out ahead of the OECD composite (see chart below). Indeed, other emerging economies such as India (below) and Brazil are also seeing clear warning flags of cyclical caution.

So are leading indicators to the leading indicators the key catalyst to follow in this market?

In a post-bubble world it is far more important for equity investors to follow the cyclical ebb and flow of the economic cycle. We know from the Japanese experience that the post-bubble equity market synchronizes extremely closely with the economic cycle. But, while in a post bubble world massive cyclical gains can still be made in a structural bear market, how does an investor know when it is time to get out of equities?

Certainly my former colleague, James Montier [whose latest, quite pessimistic piece we posted previously], derided the notion of investing on the basis of forecasts as they inevitably proved so inaccurate. It would not be too unfair to say that market and economic forecasters tend to hug the consensus and typically lag events. That is especially true at cyclical turning points. That is why it is useful to monitor proprietary leading indicators. These are especially useful in predicting economic turning points and allow the investor the opportunity to pile into or withdraw from cyclical risk assets.

We monitor a variety of such indicators and until recently they have all been giving an unambiguous green light to participate in risk assets. That has now changed. We noted on the cover the OECD leading indicators for China and other emerging markets have now topped out. But also in the US, some leading indicators have started to dive quite sharply, albeit from very elevated levels (see chart above). In Japan too, we note a topping out action (see below). Recent hard data in Japan such as the closely watched Tertiary (non-manufacturing) activity index has been surprisingly weak, suggesting their anemic recovery is already stalling.

Some more bullish commentators, while accepting that leading indicators are topping out, point to the extreme strength of the recent peak as suggestive of still more positive growth surprises in the pipeline. I think this is wrong. I was always taught that it was turning points that were accurate and hence should be watched closely, and not the magnitude of any directional movement to either the up- or downside.

Going back to macro opinions, and away from indicators, Edwards is extremely pessimistic on the overall economy: when the stimulus effects expire, the double dip will come....MORE

Finally the Big Daddy, a Feb. 12 post at ZH:

Albert Edwards: At 500% Net Liabilities To GDP, It Is Too Late To Prevent The Collapse Of The G-7; Greece Is Irrelevant, We Are All Now Insolvent

For Greece, with on and off balance sheet liabilities at over 800%, it's game over. For the Eurozone, with the same ratio at about 500%, it is also game over. For the US, at 500%+, it is, you guessed it (sorry Joseph Stiglitz), game over, but since we have the printers, it will simply take a little longer. Following up on yesterday's popular post on prevailing delusions as captured by Albert Edwards' colleague Dylan Grice, we present Albert's latest outlook. Please don't read this if you want to keep believing there is any hope left for the (developed) world.

But first some aeral photography from Dylan Grice, indicating just how far the US government is willing to go to get the population stoked about owning fixed (shouldn't it be called broken really?) income. With British QE over, and the country still to implement the same criminal annuitizing of 401(k)s that Uncle Sam is contempltating in order to make "Buy Bonds" a "voluntary" option one can't really decline, maybe letters on modern architecture building blocks is all that would works. As Edwards says: "I'm not sure leaving man-sized building blocks around the City of London is really going to make an awful lot of difference, but I suppose when your public sector deficit is around 13% of GDP, every little bit helps!"

So back to Greece, the Eurozone, and policy response in general, Edwards places the causes (and "solutions") of the escalating problem precisely where it belongs: at the core of the Keynesian systemic outlook flaw....MORE