Societe General’s Albert Edwards painting the town a deep shade of bloody red once more.
If GMO’s ‘premier league’ investor Jeremy Grantham is right and we’ve just ‘enjoyed’ the fifth great bubble of the modern era, the coming bust will surely be devastating.
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Following the market turmoil of the past few weeks, this might be a good time to revisit my end-2021 key predictions of ‘surprises for 2022’, which I summarise here in a few lines. First, “equity markets will surprise and fall sharply as US tech unravels in the first half. While valuations are currently squeezed by higher bond yields, the bigger surprise will be that tech earnings disappoint, shattering confidence in the validity of their high PE ‘Growth’ valuations”.
My second ‘surprise’ was that “if an equity bear market unfolds, investors may find that while the Powell Put still exists, the strike price may be a lot lower for equities than it was at end 2018… Would the Fed really hold back if the S&P was down 30% plus? And wouldn’t that be one huge surprise for investors?”
My third ‘surprise’ was that “easing supply bottlenecks combine with soggy commodity prices to drive US headline CPI inflation back well below 2%. Hence, I expect current inflation fears to evaporate as H1 unfolds – and bond yields to decline sharply”.
Fourth and finally, “continued growth disappointments in China in the face of tight money, force a Powell-like policy pivot…including a rapid renminbi devaluation”.
Certainly, these predictions seem to be playing out roughly as expected, with the exception of my third surprise, the rapid decline of bond yields as inflation subsides. But I am pretty convinced now that we have just seen the peak of US 10y yields in this cycle at 3.20%, just a tad below the 3¼% end-2018 peak of the last cycle. From now on however, the imminent reality of global recession will take a firmer grip on market sentiment and pricing.
It’s now consensus that the Fed will tolerate a deeper equity bear market because of the inflation situation. Still, I think investors will still be shocked when a massive 30% decline in the S&P (and all the associated carnage) doesn’t force the Fed to deviate from its current aggressive chest-beating stance. But at a decline of around 40% (close to 3,000 on the S&P), the soothing ‘brrrr’ of the QE printing presses will likely once again be heard. And that point might be closer than people think. Indeed, an important update by our NY-based Quant guru, Solomon Tadesse has increased my confidence that Fed Funds are close to the peak for this cycle. What a bizarre world it now is where a Fed Funds rate of only c.1% blows up the market!
US financial conditions have tightened considerably in recent weeks and severe cracks are beginning to be seen in the asset valuation ‘Ponzi scheme’ that the Fed et al have inflated over this last, and several previous, cycles. Like any other Ponzi scheme, it needs constant feeding with new money to keep the charade afloat. But having let the inflation genie out of the bottle, the Fed is now determined not to ease policy (yet) despite financial conditions tightening. Hence bond yields, unusually, are now rising in line with tightening financial conditions. But for how long?
My [email protected] put this fantastic 3d chart into his latest Global MarketArithmeticand on Twitter, showing we are in the midst of a valuation-led bear market, with the most expensive stocks in the market falling the quickest.
These recent events dovetail nicely with my strongest conviction call, often repeated on these pages, that the US tech sector would drive the next equity bear market into a deep slump, one compounded specifically by the huge weight of the FAANGs and technology sector more generally in the index–just the biggest 5 tech stocks comprised some 25% of the S&P 500 recently! My thinking is that most commentators are rightly focused on the vulnerability of the US tech sector to rising bond yields by dint of that sector’s ‘Growth’-style credentials. However, no-one has been making the argument that the sector would implode because profits would begin to disappoint for these ‘Growth’ stocks in a slowdown–and most dangerously, in any recession. By contrast, tech investors were delighted with the outperformance of the sector during the last recession and this only cemented their belief in the sector as a nailed-on dead-cert‘ Growth’ theme, deserving of ever superior multiples. Hence, the explosive multiple expansion of US tech, which really started around of the time of the ‘Powell Pivot’at end-2018butended at the start of this year with the sector hitting a 30x forward PE–a huge premium versus the market PE of 22x.
I absolutely believe the turmoil that US tech and internet stocks, including the FAANGs, are now experiencing is something similar to what was seen in 2000/01. Back then Nasdaq–and TMT more generally–collapsed as a long overdue recession flushed out cyclical stocks masquerading as ‘Growth’ stocks. The profit disappointments in US tech during the 2001 recession were such that the whole sector collapsed. The carnage back then was indiscriminate and the genuine ‘Growth’ babies were thrown out with the scummy cyclical bathwater.
I think GMO’s Jeremy Grantham is right. Yahoo News reports that Grantham believes “we’re in the midst of a fifth great bubble of the modern era, following the Wall Street crash of 1929, the Japanese asset bubble of 1989, the dot com blow-up in 2000, and the Global Financial Crisis of 2008.” But Grantham argues the US economy can likely weather dramatic drops in the stock market, as evidenced by the mild recession when tech stocks blew up during the dot com bubble. But when it comes to a housing crisis, he says, the economy is unlikely to come through unscathed. The dot com bubble of “2000 showed you can just about skate through a stock market event, but Japan and 2008 showed you can’t skate through a housing crisis.” Maybe the “day of reckoning” for the US housing market has arrived. Record house price inflation of around 20% yoy has just been smacked by soaring interest rates-30y fixed-rate mortgages rising from 3% at the start of the year to above 5¼% now-their highest levels since 2009. But the residential property bubble is a truly global event, and the US isn’t the worst offender.UBS calculates the bubbles are far worse elsewhere with, somewhat incredibly, Frankfurt being the biggest bubble of all-followed by the usual suspects. Having created an ‘everything’ bubble, we know from 2008 what path we are now headed down. Yes, it is different this time. It is worse!