Doom mongers have their day in the sun as markets turn
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Almost 900 professional investors crammed into a Grosvenor Square ballroom this week for one of the stranger events in the London financial calendar. They were there to hear from a man who had predicted doom for the stock market back in 1996, and largely stuck with that call ever since.
“Maybe this is the one year in ten he’s right,” said a hedge fund manager who, like most in the room, knew what to expect from Albert Edwards, a so-called alternative strategist employed by Société Générale.
The French bank has an 80-strong team to ponder and publish on the issues posed by investment strategy. But it also has Mr Edwards and his colleague Andrew Lapthorne, a specialist in data analysis, who provide a regular counterpoint of arch-pessimism.
Stockpickers, bond buyers, vultures from the world of distressed debt and managers of secretive Swiss fortunes had all come to hear about the prospects for disaster. “It’s a bit like watching a horror movie: you’re scared for a couple of hours and then you go back to real life,” said one.
Yet after the worst start to the year for stock markets in decades, with the oil price collapsing and China’s authorities intervening to shore up the value of its currency, pessimism is suddenly popular.
For instance, Royal Bank of Scotland has advised clients to “sell everything except high quality bonds”.
Investors around the world have been pushed into emerging markets, corporate debt and stock markets after seven years of very low interest rates left them with little alternative. “A big picture, multiyear bet that has been taken, which has worked fine, and stopped working 10 months ago,” according to Andrew Roberts, head of European interest rate strategy for RBS. Get out ahead of the rush, he said. “In a crowded hall, exit doors are small.”
Meanwhile, Michael Hartnett, chief investment strategist for Bank of America Merrill Lynch, has advised holding cash and derivatives which rise in value when markets convulse. An indicator of sentiment for US manufacturers is approaching a level which has coincided with 11 of the 13 recessions since world war two, he said. “The best reason to be bullish right now is there are so few reasons to be bullish.”
Mr Edwards, who long ago predicted the collapse in government bond yields, made his case with charts and gallows humour. Events playing out are the culmination of forces and policies building for years: debt funded booms, a failure to prevent them and an ad hoc approach to dealing with the aftermath.
For instance in China the authorities first encouraged a stock market bubble then failed to stop it bursting, he said, and the effect is reduced economic activity. “Demand for credit has collapsed, which happens when you lose confidence policymakers know what they are doing, and this is the shape of things to come in the US and the eurozone. Why anyone has confidence the central banks are on top of this is a total mystery to me.”
Mr Lapthorne offered a more focused assessment for the prospects of stock markets. “We are in a US profits recession,” he said, even if losses for energy companies are excluded. “Earnings have never been cut this dramatically outside a recession. The worst earnings momentum on the planet is not in Asia, it’s not emerging markets, it’s not in Europe, it’s in the US.”
Stress can be seen by the growing difference between the official or GAAP measure of profits companies must publish, and the adjusted measures they encourage analysts to pay attention to. An example is Alcoa, the US manufacturer which on Monday reported large GAAP losses. “In non-GAAP measures it actually made quite a lot of money, once you exclude anything which is negative,” said Mr Lapthorne.
The SocGen duo were joined by a guest, Russell Napier, a strategist and author who focused on the relationship between trade, currencies and the flow of capital. For years the latter has flowed into emerging markets, so a big question is what happens when the flow stops, or reverses.
“Never buy an emerging market equity when it’s cheap. Only buy an emerging market equity when the currency is cheap,” he said. The problem is that while currencies for Brazil, Turkey, South Africa and other developing nations have been losing value against the dollar for years, exports have not yet risen to the point where these countries don’t require regular inflows of foreign money.
To be cheap the currencies must fall further, which risks problems for countries, and companies, which have borrowed in dollars or euros. Currency crises and sovereign defaults remain a real possibility, said Mr Napier.
Yet for an afternoon of gloom with little relent, the mood in the audience was more pragmatic. Several attendees described it as a useful counterpoint, a way to jolt the brain out of day-to-day immersion in spreadsheets and company filings.
After all, even if the sky isn’t falling, fears that it might have always had a fascination, and exploring the possibility can be a useful way to examine assumptions about how the world works.
Mr Lapthorne acknowledged he has a curious job. “We’re paid very very well if we’re completely and utterly wrong. I suppose a bit like economists.”