SocGen’s Albert Edwards on 10% Yields and a 50% to 60% Drop | #656

Albert Edwards · Société Générale

S&P 500 will fall 50-60% at some stage; he is certain of it.

Equities will hit a brick wall as the long-term bond bear market plays out and yields climb toward 10%. The S&P forward P/E would compress to around 6 at that yield, versus about 19 now, which he says implies a fall of 50-60%. Liquidity tightening and bond vigilante pressure are the mechanisms he points to.

“We'll be seeing the S and P down 50 or 60% at some stage. That, I am certain.”at 0:44

Albert Edwards · Société Générale

Tightening liquidity is a red flag that the equity party is ending.

Michael Howell, who had been bullish, has turned and says liquidity is slowing and tightening. Money supply is rising but not enough for the demand from public and private issuance. Nominal GDP is growing about 6%, so the surplus liquidity that lifts equities is shrinking. Edwards cites the 1999 Nasdaq bubble, which popped once central banks withdrew liquidity in early 2000. He sees the same warning now.

“[Michael Howell] says the liquidity situation is really beginning to slow down and tighten here... I think is a red flag. That is I think is a sign the party is ending.”at 8:30

Albert Edwards · Société Générale

Stock gains rely on a few AI names; breadth is deteriorating, a classic bubble-top signal.

Edwards cites deteriorating market breadth, one of the classic technical signs seen in the Nasdaq bubble. He endorses the framing that stocks owe so much to so few, and that it is AI because outside of that there is not much going on. The market is therefore concentrated and fragile.

“breadth is one of them. ... Never have stocks owed so much to so few. And it's AI because outside of that, there ain't much going on.”at 37:07

Albert Edwards · Société Générale

The S&P 500 will eventually fall 50-60% as the government bond bear market hits equities.

Edwards argues that because the US is in a multi-year, multi-decade bear market for government bonds, equities will hit a brick wall at some stage, with the S&P 500 down 50 or 60%. He says valuations are still crazy and he is waiting to turn bullish only when the S&P forward P/E falls to about six times. He notes that quantitative easing derailed his earlier Japanification and derating thesis, which is why he still holds his bearish stance.

“given that we're in a multi year, multi decade bear market for government bonds now, I think equities will hit the brick wall at some. We'll be seeing the S and P down 50 or 60% at some stage.”at 49:46

Albert Edwards · Société Générale

US 10-year yields will reach 10% over the long term, in a couple of cycles.

Edwards sees a secular move: government bonds are in a multi-decade bear market and yields will rise toward 10% in a couple of cycles. The driver is fiscal indiscipline. Politicians won't consolidate because of populist anger, so the government ends up having to inflate. At 10% yields he expects the S&P forward P/E to fall to about 6, versus about 19 now.

“On a longer term base, US ten year yields are going to 10%. The S and P forward P will be at that time, more like six.”at 0:44

Albert Edwards · Société Générale

Stocks and bonds now positively correlated again; higher yields now mean lower equities.

After Japan's bubble burst in the 1990s, the bond-equity correlation flipped negative as inflation fell toward zero. Edwards's ice age thesis said that regime would end as yields rose, flipping correlation back to positive. He says we're already there: higher yields mean lower equities, which means bonds no longer hedge stocks. Fiscal incontinence and a multi-decade bond bear market drive this.

“So I think we're already there. Higher bond yields now mean lower equity prices. There's positive correlation.”at 12:54

Albert Edwards · Société Générale

US 10-year Treasury yields are heading to 10% over the longer term, after a near-term spike.

Near term, Edwards thinks the inflation genie could escape the bottle and the Fed could fall further behind the curve, so yields head up quite sharply. Once the Fed's tightening causes a recession, yields track back down, and then head down in the next recession. On a longer-term basis he sees US 10-year yields going to 10%. He frames this as a multi-year, multi-decade bear market for government bonds and cites Ray Dalio's view of a series of higher lows and higher highs for interest rates.

“So actually in the near term, on a longer term basis, I think US ten year yields are going to 10%.”at 42:25

Albert Edwards · Société Générale

Higher rates aren't hurting US corporates; large firms locked in cheap debt, so they look immune.

Larger corporates locked in near-zero rates on bonds during and after COVID, then parked the cash in deposits. So rate rises aren't squeezing their profits, which normally is how the profit cycle leads recessions. There is pain at the edges, in smaller unquoted firms and in household default segments. Corporate and household balance sheets are not over-levered as in 2008; the over-levered sector this time is the public sector.

“Actually higher interest rates do not seem to be hurting the corporate sector.”at 19:23

Albert Edwards · Société Générale

US productivity looks strong only before capital is included; with capital, total factor productivity is contracting.

Productivity growth has accelerated, up over 3% year on year. But once the capital stock is added, the total factor productivity measure is pretty poor. It is contracting after growing at about 3% eighteen months earlier, which he calls a real warning sign. He compares this to the East Asian miracle of the 1990s, when capital poured in but productivity growth was poor, and says the current US story is a mirage. He likens the US chart to Thailand or Malaysia in the mid-1990s.

“Because productivity growth has definitely accelerated. It's up over 3% year on year. But you add in the capital stock, and actually it's pretty darn poor. It's contracting after growing at about three percent eighteen months ago.”at 39:04

Albert Edwards · Société Générale

Recession is the biggest risk, unpriced by markets and ignored by Fed members.

Edwards says recession is the biggest risk, and the market treats it as inconceivable. When asked, not one Fed member saw economic slowdown as a key risk, which he finds a worrying contrary indicator. Apart from AI, he sees the cyclical economy as weak. Consumers are in a poor position to absorb higher prices, and the $5,000 checks are unlikely to reach US households in the next few weeks.

“The biggest risk which is not being priced in and is considered inconceivable of the moment is a recession.”at 41:13

Albert Edwards · Société Générale

The Fed needs about 200bp of hikes, quickly; the market is wrong pricing two or three.

Corporate greedflation has returned. Oil lifted non-labour unit costs about 10%, but productivity above 3% keeps unit labour costs near zero, so firms are raising prices to widen margins. The Fed is behind the curve and repeating 2022. Edwards argues it must do around 200bp, not 75-100bp. If markets then doubt the Fed and US yields jump 100bp, equities are finished through liquidity, even before the AI profit cycle turns.

“The market is wrong. It's not two or three rate hikes. The Fed thinks we're behind the curve here... We don't need to do 75 or 100 basis points here, we need to do 200 basis points and we need to do it pretty quickly because we got behind the curve again.”at 25:00

Albert Edwards · Société Générale

Fed tightening into rising inflation will likely cause an accident, since most tightening cycles end in recession.

Edwards sees the real market risk as the Fed tightening, with inflation picking up more than expected, enough to cause an accident. He argues that most Fed tightening cycles end in recession, and that the whole economic and market structure then implodes on itself.

“I think the real risk for the markets is actually the tightening so that inflation does pick up more than expected, that the feds do tighten sufficiently to cause an accident. Most fed tightening cycles end in recession in any case”at 42:07

Albert Edwards · Société Générale

China's fiscal situation is as bad as the US, with debt heading to infinity faster.

Per IMF figures, China's overall general government deficit, including local government, is about 8% of GDP, the same as the US, and has been for several years. China's debt-to-GDP path goes to infinity far faster than the US, and its demographics are awful. Few people appreciate how bad its fiscal position is.

“China is the one where people don't appreciate just what a mess the fiscal situation is. It is as bad as The US.”at 29:58

Albert Edwards · Société Générale

China's credit impulse has collapsed and should drag the S&P down with a one-year lag.

The change in credit growth, the credit impulse, has collapsed over the last year. Beijing won't open the floodgates despite deflation. Overlaying the S&P on the China credit impulse, leading by about a year, fits perfectly, as do industrial commodities and US cyclicals. The economy is ticking along at about 4.5% on AI and exports, but restrictive credit, the housing slump and shadow banking keep liquidity tight.

“And the China impulse has collapsed over the last year. ... Despite the deflation there, they're not opening the floodgates.”at 31:21

Albert Edwards · Société Générale

Heavy IPO and debt issuance strains existing money supply, pushing yields up absent money printing.

Issuance is a demand on the existing money supply, the same as bond issuance. US M2 growth of about 5% is not enough for the demand for credit and new issuance. Everything else being equal, that pushes yields up unless money printing offsets it. Edwards is therefore treating the IPO wave as a liquidity strain rather than a sign of health.

“It is a demand on the money supply, existing money supply. It's the same as a bond issuance. ... that will push up yields unless there's money printing”at 35:42

Albert Edwards · Société Générale

The IPO boom shows investors chasing a compelling narrative despite weak productivity returns.

Edwards says the IPOs are symptomatic of a narrative that is so compelling that investors are willing to throw money at companies. Looking at the evidence, total factor productivity growth is not producing the returns that would justify this capital spending. The question, from a macro view, is whether the rate of return on all this capital spending will come through.

“These IPOs are symptomatic of the narrative being so compelling to investors. They're willing to throw money at these companies which when you look at the evidence, a total factor productivity growth isn't producing.”at 40:02

Albert Edwards · Société Générale

Physical Brent near $150 is far above front-month futures of $110-115, so consumers face $150-200 oil.

Most market participants watch the front-month futures contract, which is about $110-115. Edwards says the physical spot rate is much higher because of shortages, with Brent spot around $150 a barrel, and he later suggests the true cost to consumers is closer to $150-200 a barrel. He adds that Vincent made the same point, and that the oil shock is leaking into agriculture.

“the spot rates for Brent for example up at Shetland is about $150 a barrel whereas the first to deliver future might be $110,115 at the moment.”at 44:08

Albert Edwards · Société Générale

Record refining crack spreads reflect capacity closures in the US and Europe, not greedflation.

Refiner margins (crack spreads) are at unprecedented highs, partly because refining capacity was taken out in the US and Europe while expanding in China and parts of Asia. The energy sector has been starved of capital, and banks do not want to finance oil. Edwards does not see these spreads as greedflation. They are piled on top of a spot crude price near $150, which is why diesel prices at the pump are so high. Refiners are running near 100% capacity, so they avoid maintenance shutdowns, and the equipment could break as a result.

“Then on top of that you've got the crack spreads, so the refiners spreads on top of that which are unprecedented highs and partly at unprecedented highs because capacity was taken out in Europe and The US.”at 44:33

Albert Edwards · Société Générale

Forward-to-trailing earnings ratio is unusually stretched, a pattern seen only when exiting recession.

Strong trailing profits and profit expectations have kept equities paddling sideways. Without them the market would be down 20-25%. But the ratio of forward to trailing earnings is unusually stretched. Historically it only gets this high when trailing earnings are depressed coming out of a recession. Here trailing earnings have done well, yet optimism is extreme, which he reads as a warning sign.

“that ratio of forward earnings to trailing earnings is unusually stretched and it only ever gets this stretched when you're bouncing out of a recession.”at 4:52

Albert Edwards · Société Générale

Current AI-led optimism looks like a bubble wrapped in a compelling narrative, as in past manias.

Edwards has seen this across the Mexican crisis, the 1997 Asian crisis and the Nasdaq bubble. Every bubble is wrapped in a fantastic narrative of optimism. What keeps it going or breaks it is the interest rate cycle and liquidity, not the story. Current analyst optimism rests on AI-driven earnings expectations, so he treats the narrative with suspicion.

“There's always a fantastic narrative which wraps around the bubble of optimism.”at 5:42

Albert Edwards · Société Générale

Social Security fund will hit zero in a few years, forcing about 25% benefit cuts.

A chart from Thorsten Slok at Apollo shows the Social Security fund being drained. It will reach zero in a few years, and benefits would then have to fall by about 25%. Politicians are too scared of populist electorates to act, which is part of the fiscal time bomb that drives fiscal dominance.

“And it's going to be at zero in about a few years time. And when we get to zero, benefits are going to have to fall by about 25%.”at 14:46

Albert Edwards · Société Générale

Fiscal dominance: politicians won't consolidate, so central banks will be co-opted into printing money.

There is no appetite for fiscal consolidation because populism and anger after globalisation and QE leave politicians unwilling to cut. A financial crisis or bond vigilantes would be the only way to force it. The US public sector took on private-sector debt after the financial crisis. About 18% of federal debt is in three-month bills and 35% is under one year. Federal interest is about 4% of GDP, far above other G7 countries. Central banks will therefore be co-opted, through financial repression, yield curve management or QE under another name.

“So you've got this situation, ticking time bombs, and ultimately central bankers will be co opted. It's part of fiscal dominance and the debasement trade.”at 15:22

Albert Edwards · Société Générale

Corporates are raising prices to expand margins again; greedflation is returning and margins are soaring.

Edwards detected a resurgence of greedflation. Non-labour unit costs rose about 10% on higher oil prices. But productivity has been strong, so unit labour costs have been running near zero and fully offset the oil shock. Corporates don't need to raise prices, yet they are doing so, and US productivity and cost data show margins soaring again. He sees this as the biggest risk to the rate cycle, since it forces a larger Fed response and could kill the profit goose.

“I think this is the biggest risk for the interest rate cycle is that corporates kill the goose which has laid the golden eggs. That they actually engage in greedflation again.”at 24:46

Albert Edwards · Société Générale

UK's 25% index-linked gilt share makes it especially exposed to rising inflation.

About 25% of the UK government bond market is index-linked. Inflation is normally a way for governments to inflate away fixed-rate debt. That escape is harder for the UK because so much of its debt is linked to prices. Together with the US, France and China, the UK is one of the fiscal bad boys he watches.

“The UK is particularly worrisome for the amount of index linked or TIPS bonds. 25% of The UK market is index linked.”at 29:34

Albert Edwards · Société Générale

US consumers are poorly placed to absorb oil-driven price increases, with no stimulus checks coming soon.

Edwards warns that corporates may use the oil-price rise to widen their margins and squeeze the consumer, who is not in a great position to be squeezed. He says the household checks are not reaching doormats in the US in the next few weeks, which leaves consumers without a cushion against higher energy and fuel costs.

“the corporates want to engage in greedflation and use the oil price rise to expand their margins more and screw the consumer, who actually isn't in a great position to be screwed. They haven't got their checks.”at 41:45

Albert Edwards · Société Générale

Investors should buy inflation hedges such as commodities and value stocks.

Edwards expects inflation to pick up and the Fed to be forced into a policy response. He recommends owning inflation hedges within equities, including commodities and value stocks, as protection against that inflationary outcome.

“I think you want to buy inflation hedges within the equity market, whether they're commodities, whether they're value stocks or whatever.”at 42:28

Albert Edwards · Société Générale

High diesel prices plus El Niño will push food prices higher over the next year.

Edwards notes that agricultural spot prices have eased recently, but he says El Niño and very high diesel prices will feed into food prices over the next year. The food price surge would come on top of the energy-driven squeeze already hitting consumers and adding to populist discontent.

“with the El Nino this is going to leach into food prices as well over the next year, these very high diesel prices.”at 46:51

Albert Edwards · Société Générale

Believes in the gold debasement trade, though extreme overbought readings mean a technical setback.

Edwards is a believer in the debasement trade, because central banks will be compelled to print money. In January, gold's monthly RSI was about 95 and its quarterly RSI was over 90, which he calls the most ludicrously stretched overbought market he has seen. He predicted a deep correction, and with gold back near $4,000 with the monthly RSI still over 70, he calls the setback purely technical rather than a change in the trend.

“I am a believer in the debasement trade because of what central banks will be compelled to do”at 50:26