Earlier this week, I attended the annual SocGen bearfest.
Each year, SocGen’s team of analysts, headed up by the (in)famously bearish Albert Edwards, present a rather gloomy prognosis for the global economy.
You could tell that markets have had a rough start to the year. The venue in central London was mobbed. Attendance was at record levels.
And if the audience was hoping for any sort of reassurance – well, they were bound to have gone home disappointed.
If this is correct, then the S&P 500 could be headed below 666
This year’s SocGen bearfest was suitably scary. Albert Edwards reiterated his ‘Ice Age’ thesis. This is essentially the idea that Japan was just a warm-up act for the rest of the world. The entire global economy will be crushed by deflation, before at some point rampant inflation kicks in as central bankers panic and take things way too far.
Edwards reckons that “the US equity market is in a valuation bear market that did not fully play itself out in March 2009, when the S&P touched the 666 level… we will see new lows.” He also reckons that the Federal Reserve’s interest rate could fall as low as negative 5%.
The current shenanigans in China are just a sign that this is happening. China devalues, and exports deflation across the globe, alongside collapsing commodity prices. Countries become locked in a competitive devaluation spiral and we end up in a situation not far off the 1930s: “an outright deflationary bust accompanied by a trade war”.
Meanwhile his colleague Andrew Lapthorne presented plenty of convincing evidence that US stocks are hugely overvalued where they are today. Not only that, but plenty of European stocks look expensive too, once you exclude the most distressed sectors.
But the star of this year’s show – the guest speaker – was Russell Napier. Russell, one of MoneyWeek’s favourite commentators and someone I suspect you’ll be familiar with if you’ve been reading for long, talked about his biggest concern.
And it was a suitably scary one.
The coming boom in sovereign busts
I’m hopefully not doing Russell’s logical, tightly-constructed argument an injustice here. But I’d sum it up as follows.
Emerging markets are at risk of going bust as capital flees their shores. They’ve got too much dollar-denominated debt. Given the choice between servicing this or protecting the best interests of their populations by defaulting on it, there’s no contest.
This in turn could cause a crisis, as that debt goes unpaid. Investors holding this emerging market debt (and there are a lot more of them these days) will panic, find they’re unable to sell in an illiquid market, and will instead sell anything else that they can get their hands on. (Not unlike in 2008.)
Meanwhile, it could easily cause another banking crisis, specifically in the eurozone. Because European banks haven’t fixed their balance sheets, and unlike US banks, they’re still holding a lot of the worst rubbish around the planet.
There’s a lot to agree with here. I agree that the strong US dollar is clearly a problem for many parts of the world. And I wouldn’t be at all surprised to see an emerging market or several run into serious trouble this year.
When they do, it wouldn’t be surprising to find out that most of that money is owed to the European banking sector. And when that happens, we’ll see how well-organised the central bank response can be, and just how worried depositors will get when they realise that they can be ‘bailed in’ to bail out the banks.
But – and here’s the rub – I also suspect that the Federal Reserve is keenly aware of all this. And I wonder how far it would let things slide before it sticks its oar in yet again. You might see an emerging market going bust. But how far back towards 666 would the S&P 500 have to slide before the Fed went into rate-cutting, money-printing, dollar-smashing overdrive?
As my colleague Cris said when we were discussing this: “What we should really be worried about is a situation that can’t be resolved by a central bank somewhere saying – ‘here, have some money.’”
There are lots of those potential scenarios too. An obvious one is a resurgence in inflationary pressures. Spiking inflation could force central banks to raise interest rates regardless. And there are plenty of political situations that could cause problems that central banks couldn’t paper over with more money.
Don’t get me wrong. I’m not saying that any of this can’t happen and we’ll be keeping a close eye on all the indicators that it might be happening. I’m just saying that you shouldn’t be sticking 100% of your money in cash and US Treasuries just yet.
In any case, Russell’s suggestions for what to buy look pretty good to us – he likes gold and Japanese equities among other things.
Enjoy our interview with Charlie earlier this week? Then watch this one now
By the way, just before I go – if you enjoyed the interview with Charlie Morris that we featured earlier this week, you should check out his latest conversation with Merryn Somerset Webb. Charlie’s going to be the new investment director of Fleet Street Letter. We’ll be telling you a lot more about that in the days to come.
For now, you can watch the interview here online.