We haven't heard from Albert in a while. The last post I can recall was seven weeks ago: "Société Générale's Albert Edwards: "Stocks Face ‘Ice Age’ Drop as Indicators Peak..." Euro to $1.25; We're all Doomed"
Here's his latest, via ZeroHedge:
Albert Edwards is out with an interesting twist on inflation/deflation. In his latest letter he notes "I have stated openly that I expect the UK 1970s experience of almost 30% inflation to be repeated in my lifetime. I also expect this to be reached in countries that got nowhere near this 30% rate in the 1970s (e.g. the US and Europe, which both peaked around 15% somewhat surprisingly Japan also hit almost 30% in the 1970s)."
Yet he counters: "But despite my belief that we will see a paradigm change over the next decade or so, I continue to retain our heavy overweight for government bonds. Recent inflation and monetary data continues to make me feel we are now only one cyclical failure from falling into outright deflation." So for the time being, Edwards is long bonds. The question is when will the secular inflation thesis become dominant and when will "rapid nominal GDP growth [appear] dragging bond yields higher." Yet at the core of any debate is the ongoing paradox of market schizophrenia: bonds continue pressing lower arguing for accelerating deflation even as stock surge higher in anticipation of inflation and the reduction of debt through surging prices and excess liquidity. Are bonds and stocks right in principle, yet disagree in terms of timing? And if so, why do stock (which tend to have a much shorter investment horizon) price in inflation first, and bonds second?
Is Albert right, or is the market simply reacting to unprecedented Fed intervention without any guidance on how to make proper asset allocation decisions? If, as we expect, Greece collapses soon, that may be the tipping point that accelerates the resolution of that fundamental quandary.
Among the economic observations Edwards uses to back up his thesis, he points to the just released CPI data...
The release of March?s US CPI inflation data emphasised that, despite the massive monetary stimulus from the US and elsewhere, the dataflow is still entirely consistent with a slow grind towards outright deflation. Core CPI inflation in the US slipped to only 1.1% yoy in March but minus 0.2% on a three-month annualised basis ?- a new low for the last few decades. Similar benign trends are also evident in the eurozone while Japan remains locked in seemingly endless and intractable deflation
...and the generally accepted insolveny of the entire world (which not even Ben Bernanke refuted when this statement was made by Ron Paul)...
Although the insolvency of industrialized governments has been highlighted by my colleague Dylan Grice, the ongoing decline in core inflation continues to underpin government bond prices. Equity investors who think this is good news should note evaporating inflation is a restraint on top-line revenue growth at a time when margins are already looking stretched ?- i.e. companies are far more reliant on revenue growth to advance profits than is cyclically normal at this stage in the cycle.
What is the appropriate asset allocation based on these observations:
The $64,000 question is whether it is still correct to stick with our winning Ice Age strategy to overweight government bonds given that both Dylan and I see the likelihood for a structural take-off in inflation before the decade is out. But I remain o/w bonds. Our long term inflationist views are not at all inconsistent with the mounting near term risk of a dip into outright deflation as/when the current cyclical upturn falters.
On the Japanese case study. We are confident Richard Koo would have something to say here:
One of the key things to remember in Japan?s lost decade was that, however low bonds yields got, they were able to go even lower in the following cyclical downturn. The long bull market in US government bonds continues to see a pattern of lower cyclical lows and lower cyclical highs. In that sense a technical analyst would define the bond bull as fully alive with all its faculties fully intact.
Anyone looking at equity (or bond) rallies (or drops) should once again refer to Japan:
While in Japan through the lost decade(s), cyclical recoveries were indeed accompanied by decisive but temporary rises in bond yields (see chart below), this was a phenomenon as equally fleeting as the cyclical rallies in the Nikkei. The key thing for survival was to identify the long-term structural trend of lower yields and lower equity prices.
Yet inflation is almost a certainty... Eventually:Similarly, the key asset allocation decision is to identify whether the current sell-off is cyclical or structural. I have stated openly that I expect the UK 1970s experience of almost 30% inflation to be repeated in my lifetime. I also expect this to be reached in countries that got nowhere near this 30% rate in the 1970s (e.g. the US and Europe, which both peaked around 15% -? somewhat surprisingly Japan also hit almost 30% in the 1970s).
But despite my belief that we will see a paradigm change over the next decade or so, I continue to retain our heavy overweight for government bonds. Recent inflation and monetary data continues to make me feel we are now only one cyclical failure from falling into outright deflation.
For the time being, dwindling inflation will restrain the pace of the nominal GDP rebound currently underway. For the eventual big sell-off in bonds we foresee, I would expect to see a repeat of the left-hand side of the chart below i.e. rapid nominal GDP growth dragging bond yields higher.