Be afraid: a new 'Ice Age' is coming
January 6, 2011
.There's a bear out there … and he's got a chilling warning for investors, writes Nils Pratley.
Sharemarkets ended 2010 on an upbeat note and there is an air of optimism among investors and a confidence among economists that a double-dip recession has been avoided. A tough moment, then, to be bearish?
Not for Albert Edwards, the best known bear in the City of London. He has seen nothing to dent his Ice Age thesis - the term he coined as early as 1996 to describe the relative decline of equities versus bonds.
He thinks there may still be another Japanese-style ''lost decade'' to endure. ''Big structural bear markets take 19 years on average and have four recessions,'' he says. ''We've had two.''
Edwards is thus sticking to two eye-catching predictions.
Sharemarkets will revisit their March 2009 lows. And, despite the hints in recent months of a return of inflation, gilt yields will fall below 2 per cent (from 3.5 per cent today) as deflationary forces reassert themselves.
And for good measure, prepare for a hard landing in China and the crash in commodity prices.
Ridiculous? Well, remember that Edwards's Ice Age call in 1996 has proved to be a winner: even if you include the sharemarket's dotcom bubble years at the end of the 1990s, equities are still a long way behind bonds since 1996.
Remember that Edwards's forecasts were rubbished at the time.
His dismissing of the supposed Asian Miracle in the mid-1990s as ''Noddynomics'' was resented - until the Asian currency crisis of 1998. To Edwards's amusement, correspondents to his employer were still trying to get him sacked in 2000. ''Send this old, sclerotic and dangerous man into pension or … take him to prison,'' said one. ''He's obviously ill and not qualified to be chief strategist of Dresdner Kleinwort. I hope his prophecy will destroy his career for the next thousand years.''
In fact, the Ice Age prophecy has been the making of his career. He started out in the Bank of England's economics department, spent three years in fund management and then had a 19-year stint at Dresdner Kleinwort until 2007. He and his colleagues (at the French bank Societe Generale) have been the top-rated analysts in the ''global strategy'' category for seven years, despite being too quick out of the blocks with some predictions.
At times, though, during the great banking bust, Edwards's views have come close to becoming consensus wisdom. The same cannot be said about his view on China.
''The biggest risk to market valuations and to sentiment generally is a China hard landing,'' he says. ''China is a much more potentially volatile economy than people think. The Chinese situation is the one that could come out of nowhere because people are not considering it as a serious possibility.''
But hasn't China been gloriously unaffected by the turmoil in the West, producing growth of 10 per cent or so with little difficulty? Edwards's argument is that ''when you have a good crisis, success can become a curse''. Japan sailed through the 1987 crash. Similarly, the US economy escaped with a shallow recession after the bursting of the dotcom bubble; house prices started to rise as the authorities declared a period of stable inflation and ''great moderation'' to be under way.
''Then what happens is that the housing and credit bubble goes out of control,'' argues Edwards. ''You tap your foot on the brakes and the whole thing starts crashing and you can't control it on the downside,'' he says. ''China is exactly the same. It had a very good crisis in 2007, opened the credit floodgates, got a house price bubble going, and they're now trying to tap their foot on the brakes.''
In Edwards's view, China is a ''freak economy"; its investment-to-GDP ratio is off the scale in terms of size and endurance. ''In development history, Korea is the only one that got close. It then collapsed. China is basing a growth model on the most unstable part of GDP. The Chinese authorities have recognised this and are trying to steer the economy over to consumption - which is fine, but it will take a long time.''
The danger is that China has produced such strong growth for such a long time that investors assume the process will last indefinitely.
''There is too much confidence in the lack of volatility. If you get a zero or a small minus for Chinese GDP, in the great scheme of long-term development it's not a great problem. But it's a bit like investing in Nasdaq stocks in 2000 - there would be a big adjustment in price. There is an investment edifice built on the idea that China is the new growth engine of the world.''
He points to the OECD's leading indicator of economic activity, which measures factors such as electricity production, freight activity and money supply. In China, it is slowing rapidly, even though commodity prices are as elevated as they were in early 2008 (prices then plunged). Something has to give - and probably sooner than most people assume. The degree of ''pushback'' from clients to his view on China reminds him of the resistance to his bearish calls on the dotcom and east Asian bubbles.
Closer to home, the Ice Age thesis suggests disappointments for the economy are inevitable. Edwards points to Japan, which enjoyed occasional rallies in share prices without conquering its long decline.
The lesson is that ''to avoid recession you need to stimulate all the way through the deleveraging phase''. That makes Austerity Britain more vulnerable to recession than the US.
The middle classes have been ''totally shafted'' by a house-price bubble that created the illusion of prosperity. ''In the US, one in eight are on food stamps. Japan was a cohesive society that shared its pain collectively. That is not how it stacks up in the US, UK, Spain, Greece etc. You have a much more fractious environment to have a lost decade in. The ructions for society will be far worse.''
So Edwards's answer to the question that obsesses investors at the moment - are we past the worst? - is a resounding no. Or, as his final research piece of 2010 put it: ''I've been doing this job long enough to recognise when the markets are entering a new phase of madness that leaves me scratching my head with bemusement.
''The notion that we are back in a sustainable economic recovery is as ludicrous as it was in 2005-07. But investors are back on the dance floor, waltzing their way towards the next, inevitable implosion, [which] yet again they will no doubt claim in retrospect was totally unpredictable!'
Reply With Quote
discussion from the Daily S&P500 index tracker thread
Originally Posted by RazorX
Bookmarks