Albert Edwards: The Fed Put is 3,000 on the S&P 500
To achieve its mission of reducing inflation, the Fed will keep raising rates, according to Albert Edwards, and won’t stop before the S&P 500 hits 3,000.
That is a 24.8% decline from its close yesterday of 3,991, on top of the 16.65% decline already this year.
Edwards is the global strategist for Société Générale and is based in London. He spoke virtually at John Mauldin’s Strategic Investment Conference on May 9.
The end of the ice age cometh
Edwards is known for his “ice age” theory, which he introduced in 1996. It was based on his observations of the end of the 1980s Japanese asset bubble.
The main risk to Japan was thought to be outright deflation, and Edwards believed it would affect the U.S. and Europe too. He deduced that Japan’s problem was “secular stagnation,” before that concept was popularized by Larry Summers and others.
The key for Edwards was that, as inflation receded to zero, bond yields would plummet.
Japan’s CPI was 5% when its bubble burst. Equity prices fell starting in 1992. As Edwards predicted, defensive and growth stocks then performed well relative to value and cyclical stocks.
Edwards foresaw a secular shift that favored long-term bonds over equities. In the early 1990s, Edwards was warning UK pension funds, which on average had 90% in equities.
But he was wrong about equities, as they have performed well for most of this century. That, he said, was because of quantitative easing (QE). But he was right about bonds, as well as value and cyclical stocks.
“The U.S. was the one market that bucked the trend on equities,” he said, because of its tech-heavy weighting. But European equities fared poorly.
Things changed during the pandemic recession with the aggressiveness of QE. “It made things look great for a while,” Edwards said, “but even bigger asset price bubbles have been built.”
What is different is during the pandemic recession fiscal and monetary policy both worked in the same stimulatory direction.
In contrast, prior to the pandemic, zero interest rates and QE were mainly used to offset fiscal tightening. But QE was increasingly ineffective and caused inequality, he said because stimulus was “pushed into the veins” of Wall Street instead of Main Street.
As a result, we are witnessing the fifth-biggest asset bubble in history, following 1929, 1989 (in Japan), 2000, and 2008.
“This is an everything bubble,” Edwards said.
Blame it on the central bankers
Indeed, Edwards pinned the blame on central bankers for inflating an asset bubble and for the collapse in equity prices this year that he expects to continue.
“If printing money was the road to success,” he said, “Argentina would be the world’s biggest economy. But it’s not.”
Investors believe central bankers are in control, but that is a false premise. That is the real risk, according to Edwards. We have reached a “Minsky tipping point” where central bankers will struggle to revive the economy but will be unable to do so.
“That is where we are now,” he said.
Housing prices are most at risk. Property-price inflation in the U.S. is “nothing,” he said, compared to Australia, New Zealand, and Canada.
“If it’s a property recession,” he said, “it will be one hell of a deep recession.”
Demand will collapse, according to Edwards, as the Fed wants it to and will overwhelm supply constraints to bring inflation down.
But inflation will be transformative. “Although central bankers and economists say they understand how the system works,” he said, “they don’t.” The Fed made a mistake with its expectation of transitory inflation. The members of the FOMC all think the same way, Edwards said, because they are pure academics unreceptive to outside opinions.
How far will the Fed go?
Edwards said a wage-price spiral is unfolding in the U.S., and central bankers are “beating their chests” about how far they will go in raising rates.
The “Fed put” is lower because of inflation, Edwards said, meaning that the Fed will be aggressive in its rate hikes to curb demand and reduce inflation, and will tolerate ever-lower prices in the stock market.
When the S&P is down 30% to 35%, the Fed will capitulate. That translates to a level of 3,000, which Edwards said will happen.
But, he said, within two to four months of reaching that level, we will be “in reverse” and will see a big rally.
The last 19 bear markets have had an average decline of 39%. But we could go “way below that,” he said. Technology will lead the way down.
Bond yields will go to “higher lows and higher highs,” Edwards said. We are approaching a secular bear market for bonds. But the cyclical recession will temporarily derail that.
When that recession unfolds, he said the 10-year yield could go back to 50 basis points.
Robert Huebscher is the founder and CEO of Advisor Perspectives.