Albert Edwards: “Clients No Longer Care About Overvaluation; They Are Concerned About Triggers And Timing”
“How do you know when an asset price rise has turned into a bubble?” That’s the rhetorical question Albert Edwards leads his today’s Global Strategy Weekly note, and responds that in the non- virtual world, valuation is often a good starting point. “A bubble can also be identified by the steepness and persistence of any price ascent as doubters and naysayers are swept away in a tidal wave of bullish froth.” We showed as much two days ago when we brought our readers the latest chart from Convoy Investments, showing that Bitcoin has now surpassed “Tulip Mania” in terms of sheer exponential price action.
Well, according to Edwards, it’s not just bitcoin: the vertical price ascent “is something the main S&P Composite Index certainly shares with Bitcoin.” And whereas one justification for the surge in stocks is a profits recovery, Edwards counters that “the underlying profits recovery looks increasingly fragile and indeed on some key measures a rapid deceleration is underway. With equities over-valued, overbullish and now also over-bought, the boring old profits cycle still needs watching.”
All of which brings us to a fundamental question: why do people avoid bubbles in the first place if – by definition – so many other investors are actively buying them up?
According to Edwards, the answer is that “investors generally agree, usually through hard experience, that to avoid or short an asset class on perceived overvaluation alone is to risk buying a one-way ticket to ruin. That is not to say that investors do not accept the basic investment principle that the primary determinant of long-term investment returns is their entry valuation. But as we have seen with equity markets in recent years, the market can stay expensive and irrational far longer than most investors can stay solvent, or indeed longer than most investment managers can retain their jobs in the face of underperformance.”
Which brings us once again to a point that Citi touched on in June, namely that every asset class iw now a bubble as “the principal central bank transmission channel to the real economy has been… lifting asset prices.” That has required continuous CB balance sheet growth. Meanwhile, as financial markets scramble to maximize every last ounce of what central bank impulse remains, we get such bubbles as London real estate, bitcoin and vintage cars, or as Citi puts it: “the wealth effect is stretching farther and farther afield.” Yes, bitcoin is merely one of the side-effects of the biggest bubble in history that central banks have blown over the past decade.
And here Stanley Druckenmiller was spot on when he told CNBC on Tuesday that the bitcoin bubble will burst – as all bubbles eventually do – but only after the far bigger central bank bubble has also finally exploded and central planning is no more:
Druckenmiller: Bitcoin, art, wine, equities, credit, you name it. everything is one way up and there are huge distortions taking place, and it’s all in the name of this 2% inflation target. And when you get a misallocation of resources, it really hinders growth over the longer term.
Going back to Edwards, he naturally agrees with Druckenmiller and Citi, and explains that clients are forced, as Chuck Prince of Citigroup famously said, to keep dancing while the liquidity mood music is playing. In fact, the SocGen strategist claims that “clients are no longer concerned with overvaluation; they are more concerned about timing and triggers.”
But instead of focusing on Bitcoin, Edwards then once again takes aim at his favorite nemesis – equities – and notes that “two key additional indicators to undermine the equity market have now fallen into place.”
As well as overvaluation, we showed recently that the extreme bullishness currently prevailing among professional advisors has not been seen in markets since (just before) the 1987 crash. In addition, amid all the focus on the parabolic rise of Bitcoin it has gone almost unnoticed that, following its rapid ascent, the main S&P Composite index is now most overbought since 1995 (see chart below). Yet even this overvalued, overbullish and overbought market might not be enough to unleash the dormant bear (see for example, John Hussman?s excellent writings).
Still, to justify his gloom, Edwards usually has some basis in reality besides merely price action, and the same is true this time, when he notes that while US EPS seems on most measures to be running at around a 10% annual clip and in the latest Q3 national income accounts (NIA), whole economy profits data confirms a 10% rise…
… if one scratches the surface, all is not well. Looking at only domestic, non-financial companies (ie companies selling in the US), profits have barely rebounded on an economic basis (ie adjusting for inventory gains and putting depreciation on an economic, rather than tax basis).
Edwards goes on to show two more cases in which US-based national profits continue to be quite anemic, and certainly not keeping up with the market’s euphoria, but his coup de grace chart is one which we recently showed courtesy of UBS, and which demonstrated that ex-energy investment, US growth has been the lowest since 2010.
And here is Edwwards:
“in addition to our concern that domestic, non-financial profits growth is so much more anaemic than headline stock market profits growth suggests, we also note that much of the rebound is driven by the recovery in the oil price. Excluding energy, the post-2015 profits surge is already decelerating (see chart below). And in an over-valued, over-bullish and overbought market, this profits deceleration might yet prove to be highly significant.”
With the oil price at 2 year highs, with net oil specs at record levels, and with US shale production set to surge in the coming weeks, the recent torrid ascent in oil prices is set to end with a bang. And, if Edwards is right, it will drag the rest of the economy – and market – with it. The good news for crypto fans is that since virtual assets are by definition removed from the underlying non-virtual reality, their ascent can continue, and in fact it will, at least until central banks finally throw in the towel and stop i) their unconventional stimulus and ii) printing money.
We won’t be holding our breath.