Albert Edwards remembers the 1987 equity crash "as if it were yesterday."
As the SocGen strategist reminisces in his latest note to clients, "one key feature was investors' surprise that the already frothy Japanese equity market and economy just sailed through the crisis more untouched than most. This was mistakenly attributed to sound policy and an unsinkable economy. As a result, confidence that Japanese policymakers could deftly manage and avert any potential crisis saw investors pour money into Japanese assets. Risk appetite inflated to previously unseen levels, and then…..."
Albert brings up this particular diversion from the real risks facing traders on that October morning in 1987 because it represents a lesson "that when policymakers have a ‘good’ crisis, investors then become over-complacent and fail to price risk correctly."
It wasn't just Black Monday: as Edwards notes, in 2001, in the immediate aftermath of the Nasdaq crash and with the expected deep recession averted, investors made the mistake of anointing Alan Greenspan with semi-supernatural powers of policy management "whereas in fact he might have just been lucky." He was.
Alan Greenspan and the Fed were seen by investors to have had a good crisis, and together with Greenspan’s mythical equity market put, investors became overcomplacent. The bust, when it came, was worse, precisely because over-confidence in policymakers’ ability to control events led to excessive risk and debt being taken on.Fast forward to today when Edwards claims that with the world suddenly focused on the US, the real trouble continues to brew enearly half a world away: namely "China is currently another place where there is over-complacency." Investors, who long ago decided to stop paying attention to the Kyle Basses of the world who repeatedly have warned about the risks posed by China's economy...
... are virtually certain that China's economy will not hard-land, mainly because the policymakers have proved the naysayers wrong time and time again. But, as in the case of 1987 and 2001, "is luck now running out?" Edwards asks, this time for Beijing.
Edwards' argument revolves around the claim with China's policymakers having had a very ‘good’ crisis in 2008 (which was papered over only thanks to trillions in new debt, as Kyle Bass' tweet above shows), "since then, naysayers, such as myself, have been consistently wrong in projecting that policymakers would lose control and that a grotesque credit bubble would burst and lay the economy low."
And yet, just like in late 2015, with the sharp swoon that followed China's devaluation and the bursting of its stock bubble, once again fears are growing about the Chinese economy slowing rapidly, even if few fear a bust. Instead, Edwards contends that as President Trump exerts mounting pressure on the Chinese economy via tariffs, "the worry is that a Chinese policy response will send the global markets into a tailspin, just as the August 2015 devaluation did."
Which, in turn, reminds the SocGen strategist that, as we reported back in August, China just unveiled its first ever current account deficit, marking a seachange in the direction of China's capital flows, and making China’s policymakers’ job even harder, once again bringing up the question: "Is luck running out?"
Of course, the current account is just a symptom of an greater malady affecting China: namely a rapid slowdown in Chinese growth. Referencing the recent work of SocGen China economist Wei Yao, Edwards notes that the swing into current account deficit shown above is likely to be permanent. The result will be increased fragility in the renminbi "at a time when economic growth is slowing sharply, led by the industrial (secondary) sector (see left-hand chart below). And with export growth to the US only temporarily buoyed to avoid tariff hikes, this slowdown is likely to intensify."
...MORE