Thursday, August 28, 2014

Much, Much More From Société Générale's Albert Edwards (28Aug2014)

Following up on the post immediately below, "Société Générale's Albert Edwards Is ALIVE!".
From FT Alphaville:

Edwards: “The equity market is now running on fumes”
Ice Age theologian, Albert Edwards of SocGen, is back from holiday with a new missive warning of imminent equity collapse.

(As a reminder the Edwards’ Ice Age thesis, which has been running since the days of the Asia crisis, predicts a world of very low inflation and near deflation, where equities de-rate both absolutely and relative to government bonds, which also re-rate in absolute terms. This long-term valuation bear market doesn’t end until the S&P 500 hits 400 and bond yields are below 2 per cent and there’s been a deep recession and blow-up in China.)

As Edwards notes, sub 1-per cent 10-year bund yields are testament to at least one part of his theory playing out as anticipated.

There’s just the tricky issue of the S&P500 breaking above 2,000 that rumbles the theory.

But, as Edwards notes, that’s all due to the artificial support the equity market has been receiving from QE. When QE ends, this support will be removed and there will be no stopping the crash, bang, wallop due.
In many respects, he says, the equity market is already running on fumes. Evidence for this comes in the fact that corporate buybacks, which have been propping up equity prices for some time, are now beginning to run thin. In their wake they leave leveraged corporate balance sheets which — in the event of higher rates — could be unable to maintain cash-flow at current rates.

As Edwards explains (our emphasis):
It is widely accepted the Fed’’s QE programme has inflated asset prices way above fundamental values (higher inequality being one unwelcome by-product). Andrew Lapthorne has identified the mechanism whereby QE, by shrinking the available stock of investable government bonds, has encouraged investors to instead gobble up other debt assets all along the risk spectrum. Companies issuing at low yields into this buying frenzy are doing what they always like doing with debt in the final throes of an economic cycle they issue cheap debt to buy expensive equity. Decent profit (cashflow growth) may be more than sufficient to cover capital expenditure and dividends, but a gargantuan funding gap emerges as companies also undertake their corporate finance zaitech activities (see chart below, Andrew also calculates that currently almost a third of all buybacks are to cover the expense of maturing management share options QE is indeed making the rich richer!)...