AP/Peter Morgan
Recession fears have largely dissipated since this summer, bolstering investor confidence in a roaring stock market.
But Albert Edwards wants investors to remember that equities at historically expensive levels don't need an economic downturn to suffer a pullback.
The bearish Societe Generale strategist known for calling the dot-com bubble said in a November 21 client note that the relentless market rally could be due for a reversal — no recession necessary.
His argument starts with the fact that valuations are high. There are many ways to measure how pricey a market is, and Edwards shared a few novel examples.
For one, US stocks are now three-quarters of the MSCI world index.
Societe Generale
Then there's the S&P 500's 12-month forward PE relative to its 12-month trailing PE — basically an indicator of how much forward optimism may be getting ahead of itself. It's shown below on the left.
Societe Generale
The chart on the right side above shows the widely followed Shiller CAPE ratio. By itself, it shows the market is as costly as it was around the top of prior bubbles. But it's also very expensive relative to European stocks, which have historically traded at similar valuation levels to US stocks.
The second part of Edwards' argument is that liquidity is drying up in the sense that the Fed is shrinking its balance sheet, which can be bad news when valuations are high. Here's the CrossBorder Capital's Global Liquidity Index, shown in black, which has dipped on a six-week basis. It implies bitcoin, a speculative asset, should be due for a drop in price versus six weeks ago.
Societe Generale
Rising 10-year Treasury yields could also cause liquidity to dry up, as investors who hold the asset will have taken a loss by selling it. Higher yields also attract capital away from stocks, as Treasurys are risk-free. Edwards said rising yields will eventually put a damper on the stock market, especially with valuations continuing to climb.
Societe Generale
"To be fair, full blown equity bear markets (-20% or worse) really only ever occur in recessions when both profits and valuations plunge. Alternatively, sharply rising bond yields can cause problems to equities in a high PE environment – such as now," Edwards said. "This is a case of an elastic band stretching to breaking point – the 1987 equity crash would be a good example."
He listed a couple more examples: "Just look at the equity euphoria back in 2018, which initially shrugged off rising bond yields – until they didn't. The same happened in 2022. At some point rising bond yields will just as surely begin to hurt equities."
Edwards has a fairly poor track record recently, having had a downbeat view on stocks and the economy while the market has soared and the economy has held up. He himself admits this in the November 21 note. So perhaps take his views with a grain of salt.
Still, he did foresee the 2000-2002 bear market, and provides, at the very least, logical arguments that are food for thought, as rallies and expansions don't last forever.
As Bloomberg Opinion Columnist and former strategist Marcus Ashworth put it last year: "The SocGen strategist's doomster scribblings are a must-read for fund managers — even if he's often wrong."
