The latest decline in employment and other economic data suggests the U.S. economy is about to, “relapse back into economic stagnation or recession…” according to Societe Generale’s Albert Edwards.
Edwards explains that without more quantitative easing, his ice age theme, in which equity prices decline, and bond prices climb, is back on.
From Albert Edwards:
The Ice Age theme is now well known. In a world of very low inflation and near deflation, equities de-rate both absolutely and relative to government bonds, which also re-rate in absolute terms. After the obscene extremes of equity valuations seen during the 2000 bubble, we have entered a long valuation bear market which should end in extreme levels of cheapness consistent with an S&P around 400. The unavoidable deep recession associated with this level (not forgetting the inevitable China bust) will drag an already ‘expensive’ bond market to even higher extremes. One of the key themes of our longer-term analysis is that at the end of one of these lengthy 15-year phases for the financial markets (shown below), investors believe that the current investment phase will continue indefinitely. That was not the case in 2009 and is not the case now. There is still far too much hope to call a bottom.
There is, however, opportunity for equity investors at the end of this long, dark tunnel they are about to go through, according to Edwards.
Investors should note how the 2001 and 2008 recessions brought about savage Ice Age de-ratings of US valuations followed by only a partial 50% recovery of the previous valuation losses during the cyclical upswing. If we are about to set out another leg in the Ice Age de-rating, the next icy ‘steppe’ in valuations could take us closer to 7x – i.e. what we would typically expect to see at the end of a secular valuation bear market. By then investors would have lost all hope as we sink into deep recession and bond yields plunge below 2%. That will be the buying signal for equities and time to offload our remaining holdings of government bonds back to the Central Banks.
Note the “steppe” Edwards speaks of. There was on sharp down leg in 2001, another in 2008, and now we’re preparing for a third, according to Edwards.
Photo: Societe Generale
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